The Bank of Japan (BoJ) has decided to maintain its benchmark interest rate at 0.5%, a move that was largely anticipated by markets, according to ING. Governor Kazuo Ueda reaffirmed that future monetary decisions will remain guided by incoming data. However, the central bank’s upgraded inflation forecast for the coming years has increased expectations of a potential rate increase as early as October.

Despite the recent trade agreement between Japan and the United States, the BoJ is taking a cautious stance, opting to first assess the economic and inflationary impact of the deal. With fiscal policy remaining uncertain, the decision to pause monetary tightening was in line with expectations. The BoJ now appears to be placing more weight on meeting its inflation target than on managing trade-related risks.

In its latest quarterly report, the BoJ kept its FY25 GDP growth forecast largely stable, raising it marginally from 0.5% to 0.6%, despite a weak start to the year. The projections for FY26 and FY27 remain at 0.7% and 1.0% respectively, indicating continued confidence in Japan’s economic resilience and a belief that recent tariffs will not cause lasting harm.

Inflation expectations, on the other hand, have shifted upward more significantly than forecast. Core inflation for FY25 is now expected to hit 2.8%, up from 2.3%, driven by rising costs in food and services. The medium-term outlook for FY26 and FY27 also reflects greater confidence that inflationary pressures will persist.

June economic indicators provided a positive surprise, with industrial output climbing 1.7% month-on-month—outperforming expectations of a decline. This recovery was led by the semiconductor and transportation sectors, buoyed by investments in artificial intelligence. Retail sales also rose by 1.0%, with broad-based gains across sectors except for fuel.

This stronger-than-expected activity prompted an upward revision of the second-quarter GDP forecast to 0.1%. While recovery remains gradual, the impact of tariffs might be less damaging than initially feared.

Political uncertainty remains a key risk. The recent election loss of the ruling coalition has cast doubt over fiscal policy direction. Although Prime Minister Shigeru Ishiba remains in post, upcoming leadership changes and the potential for policy shifts—such as tax cuts—may put pressure on government bond markets.