BOJ Sees Higher Inflation and Rate Adjustments From Late 2026

At its July 30–31, 2026 Policy Board and Monetary Policy Meeting, the Bank of Japan decided on the July 2026 Outlook for Economic Activity and Prices. Although the economy is showing some weakness partly because of developments in the Middle East, it is recovering moderately, while overseas economies are also generally growing moderately. Exports and industrial production are broadly flat as a trend, but corporate earnings remain high, business sentiment is favorable, and capital investment is increasing moderately. Personal consumption remains resilient against a backdrop of improving employment and income conditions, while housing investment is declining.

In fiscal 2026, rising crude oil prices since early spring will weigh on corporate earnings and households’ real income through such channels as worsening terms of trade, while global AI-related demand, wage increases from the spring labor-management negotiations, and the government’s measures to ease the energy burden will support the economy. Growth will remain positive despite slowing, and from fiscal 2027 onward the growth rate is expected to rise gradually as the effects of higher oil prices fade and a positive cycle from income to spending strengthens.

On prices, in addition to the pass-through of higher wages into prices, higher crude oil prices, increases in semiconductor and other prices associated with AI-related demand, and the recent depreciation of the yen will push prices higher. The year-on-year rate of increase in consumer prices excluding fresh food is expected to rise clearly above 2% from the second half of fiscal 2026, then narrow toward around 2%. The underlying rate of increase is expected to reach a level broadly consistent with the price stability target from the second half of fiscal 2026 through fiscal 2027 and to remain at about the same level thereafter.

According to the majority of Policy Board members’ forecasts, real GDP is expected to grow year on year by +0.6–+0.7% in fiscal 2026, +0.7–+0.8% in fiscal 2027, and +0.7–+0.8% in fiscal 2028, with medians of +0.6%, +0.8%, and +0.8%, respectively.

For companies, worsening terms of trade caused by higher oil prices will pressure earnings, while AI-related demand, backlogged orders from existing projects, the government’s economic measures, and accommodative financial conditions will support capital investment. From fiscal 2027 onward, lower crude oil prices, increased domestic and overseas demand, labor-saving investment, capacity expansion in growth areas such as AI, and investment responding to changes in trade structures and supply chains will boost corporate activity.

For households, higher wages, wealth effects from rising stock prices, and income transfers through government measures will support consumption, but price increases centered on energy prices will pressure real income, and personal consumption is expected to remain broadly flat for the time being. Once the pace of price increases moderates, consumption is expected to return to a moderate upward trend from fiscal 2027 onward.

In policy management, importance is placed on stabilizing the underlying rate of price increases at around 2%. Financial conditions remain accommodative, financial intermediation is smooth, and the financial system as a whole remains stable. At the same time, the effects of asset prices, developments in the Middle East, the profitability of AI-related investment, and developments in overseas nonbank sectors on the financial system must continue to be monitored.

Among government measures, energy burden relief measures and free education policies will push down consumer prices in fiscal 2026, while increases in medical and long-term care costs and defense-related spending will affect government consumption. Government investment in growth areas could raise the potential growth rate. Labor shortages will encourage labor-saving investment, but soaring material prices and insufficient substitution between capital and labor could constrain growth.

The economic outlook is prepared by each Policy Board member based on policies already decided, while market pricing is used as a reference for future policy management. Based on futures markets and other sources, the crude oil price assumption starts at around 80 US dollars per barrel for Dubai crude and declines to around 70 US dollars per barrel toward the end of the outlook period. However, domestic companies’ procurement prices may not fall as much as international market prices because of transportation costs associated with alternative sourcing from outside the Middle East.

In the corporate sector, exports and production are expected to remain broadly flat for the time being, supported by AI-related demand despite the effects of developments in the Middle East. Capital investment will be supported by the resolution of backlogged orders, the government’s economic measures, and accommodative financial conditions. From fiscal 2027 onward, labor-saving investment, capacity expansion in growth areas such as AI, and investment responding to changes in supply chains and trade structures will become sources of increase. In the household sector, tight labor supply and demand and continued increases in nominal wages will support conditions, while housing investment will decline moderately in line with housing prices and demographic trends.

The majority of Policy Board members’ price outlook is for the consumer price index excluding fresh food to increase by +2.3–+2.7% in fiscal 2026 (median: +2.5%), +2.2–+2.5% in fiscal 2027 (median: +2.4%), and +2.0–+2.2% in fiscal 2028 (median: +2.0%). The consumer price index excluding fresh food and energy is expected to increase by +2.3–+2.6% in fiscal 2026 (median: +2.5%), +2.2–+2.7% in fiscal 2027 (median: +2.6%), and +2.1–+2.3% in fiscal 2028 (median: +2.2%).

The risk assessment monitors the effects of higher crude oil prices resulting from developments in the Middle East, overheating or insufficient profitability in AI-related investment, price increases for semiconductors, materials, and machinery, and higher import prices caused by yen depreciation. Adjustments in China’s real estate and labor markets, fiscal expansion and trade policies in various countries, and labor shortages caused by demographic trends will also affect growth and prices. The economic outlook is broadly balanced between upside and downside risks, but upside risks to the price outlook are substantial, requiring attention to the possibility that the underlying rate of increase could exceed the 2% price stability target.

Under the 2% price stability target, the Bank of Japan conducts monetary policy through two pillars that assess the central outlook and the risks that require attention. Given that the underlying rate of price increases is approaching 2% and financial conditions are accommodative, the Bank will raise the policy rate and adjust the degree of monetary easing in response to economic, price, and financial conditions. The timing and pace of adjustments will be determined after confirming developments in the Middle East, AI-related demand, exchange-rate movements, and the likelihood and risks of realizing the outlook. Emphasis is placed on stabilizing the underlying rate of price increases at around 2% and achieving the target sustainably and stably.