Oil, war and inflation: Japan’s price puzzle deepens as central bank faces tough call

Japan’s fragile inflation recovery is once again facing a global test, this time from geopolitics. Fresh data shows price pressures are beginning to re-accelerate, driven largely by the ripple effects of the Iran conflict on global energy markets. But beneath the surface, the story is far more complex and potentially troubling for policymakers.

Core inflation in Japan, which excludes volatile fresh food prices, rose to 1.8 per cent in March, marking its first increase in five months. While modest on paper, the uptick signals a shift: global energy shocks are starting to filter into domestic prices.

Yet, the broader inflation picture remains uneven.

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Headline inflation came in at 1.5 per cent, still below the 2 per cent target of the Bank of Japan (BOJ). Even more telling, the “core-core” measure, stripping out both food and energy, slipped to 2.4 per cent, suggesting underlying demand in the economy is softening. This divergence is at the heart of Japan’s inflation dilemma.

Energy shock vs weak demand

At the center of the latest inflation push is the Iran war’s impact on oil markets. With crude prices surging and supply routes under stress, Japan, an energy-import-dependent economy, is directly exposed. The Strait of Hormuz disruption alone has amplified costs across fuel, transport, and manufacturing supply chains. But Tokyo has attempted to blunt the blow.

The government has rolled out fuel subsidies and even released crude from strategic reserves to contain price spikes. These measures have helped bring down energy costs by 5.7 per cent in March, cushioning households from the worst of the shock. Prime Minister Sanae Takaichi has gone further, proposing a cap on gasoline prices at 170 yen per litre, warning that unchecked prices could touch 200 yen.

However, such interventions come at a steep fiscal cost, estimated at nearly 300 billion yen per month. This creates a paradox: while global forces are pushing inflation higher, domestic policy is actively suppressing it.

The BOJ’s tightrope walk

For the BOJ, the current situation complicates an already delicate policy path. On one hand, rising energy prices and inflation expectations strengthen the case for continued monetary tightening. A recent survey showed over 83 per cent of households expect prices to rise over the next year, an important signal for central bankers trying to anchor inflation expectations.

On the other hand, much of the inflation is “cost-push”, driven by imported energy rather than domestic demand. This kind of inflation can erode real incomes and dampen consumption, raising the risk of stagflation-like conditions.

Markets widely expect the BOJ to hold interest rates at around 0.75 per cent in its upcoming meeting, but with a hawkish tilt. Analysts suggest the central bank may signal readiness to act if inflation accelerates further, especially amid concerns over yen depreciation and imported inflation.

A fragile economic backdrop

The broader economic context adds another layer of complexity.

Japan narrowly avoided a technical recession in late 2025, with modest growth of 0.3 per cent quarter-on-quarter. But growth remains fragile, and rising import costs threaten to weigh on both corporate margins and household spending.

Meanwhile, producer prices and logistics costs are already surging. Ocean freight costs, for instance, have jumped sharply, an early indicator that consumer prices may rise further in coming months.

Economists warn that if oil prices remain elevated and subsidies are scaled back, core inflation could approach 3 per cent by the end of fiscal 2026. But this would likely come at the expense of purchasing power, limiting any real demand-driven inflation.

The bigger picture

Japan’s current inflation phase highlights a deeper structural issue; it still lacks self-sustaining price momentum. Unlike the US or Europe, where wage growth and demand have driven inflation cycles, Japan’s price increases remain heavily dependent on external shocks. Even recent wage hikes, including strong “shunto” negotiations, may not fully offset rising living costs. This leaves policymakers balancing two conflicting risks: tightening too early and choking growth, or waiting too long and losing control of inflation expectations.

The road ahead

As the Iran conflict continues to reshape global energy markets, Japan finds itself caught in a familiar bind: imported inflation without domestic strength. For the BOJ and the government, the next few months will be critical. Whether inflation proves durable or fades once energy prices stabilise will determine the future of Japan’s long-awaited economic normalization. For now, the message from the data is clear: Japan’s inflation story is no longer just domestic; it’s global, volatile, and increasingly unpredictable.