Former Bank of Japan official warns: Japan's economy may fall into stagflation due to the impact of the Middle East conflict

Source: Global Markets Broadcast

Former Bank of Japan official and Rakuten Securities Economic Research Institute chief economist Nobuyasu Atago said on Thursday that Japan's economy may face supply shocks and declining demand risks resulting from the Iran conflict, while the Bank of Japan might be overlooking this risk due to its focus on inflationary pressures.

The Bank of Japan’s recent series of hawkish statements has led the market to generally expect about a 70% chance of a rate hike in April, as the Middle East conflict sends oil prices soaring, the yen weakens, and import costs rise, increasing inflationary pressure.

Although the Bank of Japan kept interest rates unchanged in March, policymakers are still discussing whether to raise rates further, with some concerned the central bank might act too slowly in addressing inflation risks.

Atago warned that anticipated shortages of naphtha and other chemical products produced during the oil refining process may present a greater risk and could damage the economy.

"Much like a natural disaster, in the face of this crisis, what we need to consider is a major disruption to the flow of goods rather than worrying about how high prices could go,” Atago said.

"What the Bank of Japan needs to consider is not whether to raise rates in April, but how to inject liquidity into the market to prevent a recession and the bankruptcy of some businesses."

Since the U.S. and Israel launched strikes against Iran, markets have been turbulent. The conflict has effectively shut down the Strait of Hormuz, a passageway for about one-fifth of the world's oil and natural gas shipments, driving up crude oil prices.

On Thursday, U.S. President Trump vowed to launch even tougher strikes against Iran, ending hopes for a quick resolution to the conflict and exacerbating the predicament for countries like Japan that depend on Middle Eastern oil and naphtha imports.

The majority of naphtha consumption is in petrochemicals, where it is cracked in steam crackers to produce ethylene and propylene—core feedstocks for plastics, synthetic fibers, and other products.

Atago said that a naphtha shortage would hit factory output and that damage to the overall economy would worsen starting this quarter.

He noted that although government data show Japanese manufacturers expect output to rise by 3.8% in March, actual output may decline as this estimate does not account for the impact of the conflict.

He added that any restrictions the government imposes on economic activity to curb fuel consumption could also dampen demand during Japan's tourist season beginning in May.

Atago stated: "Japan may experience stagflation this summer, with prices surging and the economy contracting at the same time."

He also noted that the Bank of Japan might be using its nationwide network of branches to gather information on petrochemical company operations, and that this information could appear in the regional economic report released on Monday.

But he pointed out that this data may not be sufficient to persuade the hawks among the Bank of Japan’s policymakers to change their stance.

Atago said: "In times like this, policymakers need to listen to the voices of businesses and grassroots citizens. However, institutions like the Bank of Japan, which are made up of economists accustomed to studying macro data, are not adept at hearing public opinion."