The Bank of Japan is coming under intensifying pressure from policymakers, advisers, and even some of its own board members to scrap its reliance on an “underlying inflation” measure that many see as opaque, and to move towards a more transparent, potentially tighter, policy stance. Governor Kazuo Ueda has defended the gauge, which emphasises domestic demand and wage growth, as a prudent basis for caution, yet headline and core inflation have remained above the bank’s two percent target for over two years, with headline inflation hitting 3.3 percent in June.
Minutes from the BOJ’s July policy meeting revealed that at least one board member urged a pivot towards more conventional benchmarks, including observed price movements, inflation expectations, and the output gap, warning that second-round effects could already be embedding inflation into consumer and business sentiment. This view is echoed by government economic advisers, who caution that the central bank risks falling behind the curve if it maintains its current approach.
The policy debate is shifting as external conditions improve. A recent U.S.–Japan trade agreement has eased growth concerns, giving the BOJ more scope to consider gradual tightening. Discussions have already touched on the possibility of resuming rate hikes by year-end to avoid having to implement more abrupt increases later.
For the BFSI sector, the implications are far-reaching. Clearer communication and earlier rate increases could reshape bond portfolio valuations, lending margins, and deposit strategies. Banks holding large positions in long-dated government securities may face mark-to-market losses, even as rising interest rates offer the potential for improved net interest income. Insurers and pension funds could find fresh opportunities in higher-yield government debt, while asset managers may need to recalibrate fixed-income allocations and client guidance.
The central bank’s willingness to reconsider its inflation framework could signal the start of a more decisive tightening cycle. For financial institutions, preparing balance sheets, risk models, and communication strategies for a transition from prolonged monetary accommodation to firmer policy will be critical to staying ahead of a rapidly shifting rate environment.
