BoJ Governor Kazuo Ueda said an identical oil price rise can produce different outcomes depending on wages, inflation expectations, demand conditions and exchange rates, according to Reuters. He referred to supply disruptions as an increasingly common concern and said central banks should not focus solely on moves in oil prices when assessing inflation dynamics.
Ueda said higher inflation expectations combined with rising wages can raise the risk of second-round effects, while low expectations and stagnant pay can keep underlying inflation contained even after a large cost shock. He added that the boundary between temporary and persistent inflation is not fixed: a one-off shock can become lasting if it changes wage formation, expectations and price-setting behaviour, yet even a major shock may remain temporary if these transmission channels do not activate. He also said Japan’s post-2021 energy shock helped move the economy away from deflation without triggering a 1970s-style wage-price spiral. The USD/JPY was down 0.15% at 159.22.
BoJ Policy Focus Shifting Beyond Oil Prices
We see that the Bank of Japan is signaling that its reaction function is more complex than simply looking at oil prices. The key for us is how an external cost shock, like rising energy prices, translates into domestic wages and inflation expectations. This means our focus should shift from the headline commodity price to Japanese labor market data.
Recent oil price movements support this view, with Brent crude rising over 10% in the last quarter to near $95 per barrel due to persistent geopolitical tensions. However, we believe the BoJ will tolerate this as long as it doesn’t trigger a wage-price spiral. Our models will therefore place a lower weight on energy inputs and a higher weight on inflation expectation surveys.
The most critical data point has been the recent “shunto” spring wage negotiations, which resulted in an average increase of 4.5%, the highest in over three decades. This strong wage growth, continuing a multi-year trend, is precisely the kind of transmission channel that could turn a temporary energy shock into lasting inflation. It raises the probability of a BoJ policy normalization action within the next two quarters.
Strategic Positioning Amid Yen Volatility and Inflation Dynamics
Given this, we are looking at options strategies that benefit from increased yen volatility. With USD/JPY hovering near 159.22, the market may be underpricing the risk of a hawkish surprise from the central bank. We are considering buying out-of-the-money JPY calls to position for a sharp appreciation in the currency should the BoJ act to defend it.
This view is reinforced by the historical context of Japan’s multi-decade battle with deflation. The energy shock that began in 2021 was initially welcomed as a way to unmoor deflationary expectations. Now that those expectations have shifted and wages are finally rising, the BoJ’s pain threshold for inflation is likely much lower.
The persistent interest rate differential with the United States, where the federal funds rate remains above 5% following stubborn inflation data, continues to pressure the yen. This external factor makes the BoJ’s domestic inflation calculus even more sensitive. We are positioning for the moment this domestic pressure outweighs the external rate differential, which we see as an increasingly likely scenario before year-end.
