The Bank of Japan (BOJ) held interest rates at 0.75% in its latest monetary policy meeting, citing the impact of the conflict in Iran as increasing global economic uncertainty and putting downward pressure on energy prices, particularly on Japan's oil imports, which are heavily dependent on the Middle East. This decision also reflects caution in balancing between boosting inflation and not slowing domestic economic growth.

The BOJ explicitly acknowledged that inflation risks are now likely to increase due to the surge in oil prices resulting from the Iran war, a phenomenon known as "cost-push inflation," where higher prices stem from disruptions to global supply, rather than increased domestic demand.

Japan is one of the countries most vulnerable to global oil shocks, as approximately 95% of its oil needs are imported through the Strait of Hormuz; if energy flows remain disrupted, energy import costs could widen the trade deficit and accelerate domestic inflation.

Inflation in Japan was relatively moderate before the war, but new data to be released indicates that surging energy costs have begun to affect the consumer price index, obscuring the downward trend in inflation seen before the conflict. The weakening yen is also exacerbating import price pressures.

Conflicts in the Middle East, particularly the war involving Iran, have effectively closed the Strait of Hormuz, a vital waterway carrying approximately 20% of the world's oil supply. This disruption has triggered a surge in oil prices that is faster than any previous major energy crisis.

The surge in global oil prices has pushed Brent crude above US$100 per barrel, pushing energy costs in many countries to their highest levels since the beginning of the decade, directly contributing to inflationary pressures in both developed and developing economies.

The impact of the energy price surge is not only visible in Japan; global bond markets have seen sharp increases in yields, reflecting investor concerns that a prolonged war will prolong the period of high inflation and reduce the scope for central banks to lower interest rates.

The global monetary outlook is changing rapidly, with financial markets now increasingly pricing in the possibility of interest rate hikes by major central banks such as the US Federal Reserve and the ECB, rather than the previously anticipated rate cuts.

Energy analysts believe that even if the conflict subsides within a few weeks, global oil and gas supplies may remain tight, as the region's energy infrastructure has been damaged and geopolitical tensions carry a higher risk premium on long-term commodity prices.

Surging energy prices and monetary policy uncertainty have also driven down stocks on many global exchanges, while bond yield indices signal changing expectations for inflation and future economic growth.

From Japan's perspective, the effects of imported inflation driven by energy prices differ from the inflation the BOJ desires (which is ideally driven by rising wages and domestic demand), creating a policy dilemma for Tokyo's monetary policymakers.

Overall, this combination of geopolitical and energy pressures creates a risk of medium-term stagflation in many advanced economies, where prices rise while output growth slows, forcing monetary and fiscal authorities to coordinate more carefully to balance price stability and economic growth.

Sources by CNBC