Japan's inflation numbers have been underwhelming lately. In May 2026, the core Consumer Price Index rose by just 1.4% year-over-year, followed by a slightly better but still modest 1.6% in June. Both figures fall short of the Bank of Japan's (BOJ) 2% inflation target. This slide puts pressure on the BOJ to adjust its current forecast, which sits at 2.8% for the fiscal year ending in 2026, a significant gap signaling a likely downgrade.

The lower-than-expected inflation is largely due to several factors coming together unexpectedly. Government fuel subsidies have helped ease energy costs, while food prices declined rather than spiked. Crude oil prices, often volatile due to Middle Eastern geopolitical tensions, haven't maintained the steady climb that economists anticipated, dampening the inflation outlook.

Just a few months ago, analysts had sharply increased their inflation expectations from around 1.9% to 2.8%, banking on rising energy prices as a main driver. That prediction missed the mark, showing how tricky it is to project inflation in these volatile times. Japan's return to sustained inflation after years of deflation was historic, yet maintaining that upward momentum is proving to be a tougher challenge.

The BOJ faces a tricky balancing act. While inflation lags behind target, economic growth forecasts for the fiscal year might actually be revised upward in the upcoming July report. That means growth could improve while prices remain subdued, complicating policy decisions.

For now, the central bank is expected to stay put on interest rates. Raising rates when inflation is far below target would be counterproductive. The BOJ’s continued accommodative stance means it will likely keep rates low, supporting liquidity in global markets through the yen carry trade. This trade involves borrowing in low-interest yen and investing in higher-yielding assets worldwide, including cryptocurrencies.

Any signals from the BOJ about extending its easy monetary policy could boost risk assets by fueling more carry trade activity, while an unexpected tightening might trigger a swift unwinding of these positions and impact market liquidity.