Japan's government has signaled it's ready to protect the economy from recent turmoil in the Middle East.
The main trigger is a sudden energy shock. Following U.S.-Israeli strikes on Iran, the Strait of Hormuz—a critical channel for oil tankers—has seen severe disruptions. This caused insurance companies to cancel war-risk coverage, effectively halting much of the traffic. For Japan, which imports over 90% of its crude oil from the Middle East, this is a direct economic threat, immediately driving up energy costs. Brent crude prices quickly jumped over $80 per barrel, representing a potential multi-billion dollar increase in Japan's annual import bill.
This energy crisis is amplified by a second factor: the weak yen. Earlier in the year, the yen had weakened to nearly 158 per dollar. A weak currency makes imports, like oil, even more expensive for Japanese consumers and businesses. The situation was serious enough that both Japan's Finance Minister and the U.S. Treasury Secretary issued coordinated warnings against "one-sided" currency moves, keeping the possibility of direct intervention in the foreign exchange market on the table.
Crucially, despite these rising prices, Finance Minister Katayama stated that Japan is "not fully out of deflation." This might sound contradictory, but it points to a deeper issue. The current inflation is driven by external supply shocks (cost-push inflation), not strong domestic demand. In fact, underlying inflation has been slowing, and real wages for Japanese workers actually fell again in 2025. This shows that the domestic economy is still fragile, and policymakers are hesitant to declare a final victory over the long battle with deflation.
Therefore, the government's response is focused on near-term stabilization rather than broad monetary tightening. We can expect measures like extending energy subsidies, potentially releasing strategic oil reserves, and maintaining a watchful eye on the yen. The Bank of Japan, which only recently ended its negative interest rate policy, will likely remain cautious, as raising rates to combat this type of inflation could harm the delicate domestic recovery. Japan is navigating a difficult path: shielding its economy from an external shock without derailing its long-term goal of achieving sustainable, demand-driven inflation.
- Deflation: A persistent decrease in the general price level of goods and services. It is often associated with economic stagnation, as consumers delay purchases in anticipation of lower prices.
- Strait of Hormuz: A narrow waterway between the Persian Gulf and the Gulf of Oman. It is the world's most important chokepoint for oil shipments.
- Cost-push inflation: Inflation caused by an increase in the costs of production, such as wages or raw materials (like oil), rather than by excess demand.