A key underlying inflation metric tracked by the Bank of Japan rose 2.3% in July from a year earlier, marking yet another month of solidly exceeding the central bank's 2% target. This reading, which strips out fresh food prices and other volatile components, landed well above the 1.8% gain in the government's core CPI released last week, providing crucial support for the BOJ to press on with normalizing its ultra-loose monetary policy.

The indicator is one of several new price gauges introduced by BOJ Governor Kazuo Ueda in March to filter out the distorting effects of government subsidies on gasoline and utilities, allowing for a cleaner read on underlying inflation trends. After removing those state intervention effects, the 2.3% print suggests Japanese companies are passing on higher energy costs stemming from the Middle East conflict to consumers at a faster clip than official data indicates. That outcome directly reinforces the BOJ's stance of remaining highly vigilant to upside risks to prices.

Market pricing for a September move has surged following the release. Overnight index swaps now show traders assigning roughly an 80% probability that the BOJ will raise its policy rate by 25 basis points to 1.25% at the September 18 meeting, a sharp jump from around 23% priced in ahead of the July gathering.

Seiji Adachi, a former BOJ board member, argued that the central bank has "basically been backed into a corner" — with markets almost fully pricing in a hike, a failure to act could trigger another sharp slide in the yen. He expects that after a September increase, the BOJ could move again as early as January next year, lifting rates to 1.25% or even above 1.5%.

Mizuho also views a September hike as "quite likely" and anticipates the interval between policy actions could shorten from roughly six months to three months. Goldman Sachs, which on August 25 revised its BOJ outlook, now expects the central bank to begin hiking in September, moving up its previous forecast of January 2027. The investment bank projects further increases in January and July 2027, which would take the policy rate to 1.75%. A separate survey of economists suggests the BOJ policy board could raise the benchmark rate to 1.75% by the third quarter of 2027.

Yen pressure and US influence create a policy push

The dollar remains near 159.10 yen, hovering just below the psychologically significant 160 threshold. The rare joint currency intervention by the US and Japan in late July — the first since 1998 — briefly strengthened the yen from around 164 to 155, but much of that ground has since been given back, with the pair trading back near 159.

US Treasury Secretary Scott Bessent has made clear that currency intervention needs to be followed up by monetary policy action, and expressed strong confidence that Ueda will deliver. Adachi noted that Bessent's remarks hand Ueda a "good opportunity," making it harder for the administration of Prime Minister Shigeru Ishiba, who tends to favor economic stimulus, to oppose a rate hike.

People familiar with the matter say the government, led by the prime minister, currently supports a BOJ move in either September or October, with both sides aligned on enhancing the effectiveness of FX intervention and curbing imported inflation.

Ueda said on July 31 that with underlying inflation approaching the 2% target, it is "necessary to be more mindful of upside risks to prices than before," and that he intends to delve into the topic starting from the next policy meeting. He projects the year-on-year change in core CPI to accelerate to "clearly above" 2% in the second half of fiscal 2026.