Escalating tensions in the Middle East are disrupting Japan’s bond market and casting uncertainty over the Bank of Japan’s (BOJ) next interest rate decision, as investors weigh the economic fallout from a prolonged Iran conflict.
Japanese government bonds initially reflected reduced expectations of an imminent rate hike. The two-year JGB yield—highly sensitive to BOJ policy moves—fell 3 basis points to 1.215% on Monday after joint U.S.-Israeli strikes on Iran rattled global financial markets.
The situation intensified after Tehran launched missile attacks in retaliation for the killing of Supreme Leader Ali Khamenei. Meanwhile, U.S. President Donald Trump indicated that military operations against Iran could continue for weeks. A prolonged conflict could push energy prices higher and weaken the yen, raising concerns about imported inflation and complicating the BOJ’s policy path.
Hiroshi Namioka, chief strategist at T&D Asset Management, said the central bank may be forced to accelerate rate hikes if oil prices continue rising and the yen depreciates further. “Higher energy costs would fuel inflation, and the BOJ may need to act sooner,” he noted, adding that the bank may already be lagging behind.
The BOJ raised its benchmark rate in December and signaled further tightening as part of efforts to normalize policy after years of aggressive monetary stimulus. Previously, markets had expected the next rate hike around June or July, but persistent yen weakness shifted expectations toward as early as April.
On Monday, BOJ Deputy Governor Ryozo Himino stated that market volatility would not automatically delay rate increases, though he emphasized that any decision would depend on inflation stabilizing near the bank’s 2% target. He did not provide a timeline.
Analysts say Japan’s bond market is experiencing conflicting pressures. Safe-haven demand could support bond prices, while fears of rising inflation may prompt investors to sell bonds in anticipation of tighter policy. Noriatsu Tanji, chief bond strategist at Mizuho Securities, suggested that central banks—including the BOJ—may prioritize inflation control over economic slowdown risks, potentially adopting a more hawkish stance even if growth weakens.
However, some analysts argue that a prolonged Iran crisis could hurt Japan’s economy more broadly, strengthening the case for caution. Prime Minister Sanae Takaichi, who has advocated expanded fiscal stimulus, is believed to be wary of aggressive monetary tightening that could slow growth.
Naoya Hasegawa, chief bond strategist at Okasan Securities, said that because the BOJ views underlying inflation as still below 2%, it may focus more on supporting the economy. As a result, a rate hike in April—once considered likely—could be postponed if geopolitical tensions persist.