Japan’s Economy Gets Hit by Tariffs, But the BOJ Still Hints at More Rate Hikes

Recently, Bank of Japan Deputy Governor Shinichi Uchida made a noteworthy comment in the Diet: if the Japanese economy recovers from the current shock—largely triggered by U.S. tariffs—the central bank will continue raising interest rates.

His statement was more than just forward guidance; it subtly reflected the dilemma Japan faces today. Just as signs of recovery emerge, the global environment tightens the noose.

Japan’s Recovery Interrupted Just as It Begins

In 2024, Japan finally exited over a decade of ultra-loose monetary policy. Earlier this year, the BOJ raised its policy rate to 0.5%—a historic move after years of negative rates. Optimism followed, with many expecting Japan to step out of its deflationary shadow and enter a mild but sustained recovery phase.

Then reality struck.

According to recent data, Japan’s GDP contracted in Q1 2025—the first decline in a year, and worse than expected. This wasn’t driven by domestic weakness, but by external pressure: a new wave of U.S. trade protectionism is rolling in, and Japan is directly in the line of fire.

In short, just as Japan tried to move forward, it stumbled into another trade war.

Why Talk of Rate Hikes Amid a Slowing Economy?

It may sound counterintuitive: if the economy is weakening, why consider more rate hikes?

This requires an understanding of Japan’s long struggle with deflation. For decades, Japan battled stagnant growth and persistently low prices. The BOJ tried everything—zero rates, asset purchases, yield curve control—but progress was slow and fragile.

Now, for the first time in years, inflation and wage growth are showing signs of life. The BOJ doesn’t want to squander this momentum. That’s why Uchida emphasized: if the current shock proves temporary and the data stabilizes, the central bank remains ready to raise rates further. It’s not about being aggressive—it’s about ensuring inflation expectations don’t collapse again.

How Much Damage Can U.S. Tariffs Do?

This isn’t the first time Donald Trump has used tariffs as leverage. Back in 2018–2019, his administration launched a trade war against China, shaking global supply chains. Now, he’s back, and the focus has shifted to allies—including Japan.

The U.S. is raising import duties on cars, components, and high-tech goods—ostensibly to protect American jobs, but clearly tied to electoral politics.

For Japan, this is more than a nuisance:

• Exports account for nearly 20% of GDP, and the U.S. is its second-largest market.

• Japan’s industrial ecosystem is deeply globalized—auto, electronics, semiconductors—all are vulnerable.

• Slower exports hit corporate profits, which then ripple into wages and consumption.

This is why, despite its hawkish tone, the BOJ repeatedly underscores that the economic outlook is “highly uncertain.”

Inflation Isn’t Always a Sign of Strength

Uchida also pointed out another crucial issue: much of Japan’s current inflation comes from cost-push factors—especially food and energy. For example, rice prices are rising fast.

In other words, this is not the healthy, demand-driven inflation that central banks typically welcome. It’s the kind that squeezes households and dampens consumption.

The BOJ is now walking a tightrope:

• If it doesn’t hike, inflation risks fading—Japan could slide back into deflation.

• If it tightens too much, it may crush an already fragile recovery.

My View

Japan is at a critical inflection point—it cannot afford to revert to extreme easing, but it also lacks the room for aggressive tightening.

From a global investor’s perspective, I’m watching three key dynamics:

1. Yen exchange rate: If the Fed keeps hiking while the BOJ holds steady, the yen could continue weakening, affecting capital flows and positioning.

2. Export sector profitability: Especially in autos, electronics, and semiconductors—watch for the concrete impact of U.S. tariffs.

3. Policy flexibility signals: Markets are likely underestimating how nimble the BOJ might become. Any dovish pivot or pause in hikes could ripple through global bond and FX markets.

In short, Japan is trying to escape deflation—but the external environment is pushing it into decisions it can’t fully control.