Prospects of sustained wage gains in Japan and the boost to import costs from a weak yen have heightened attention within the central bank to rising inflationary pressures that may lead to an upgrade in its price forecast this month, sources said.
Even if the Bank of Japan were to raise its inflation forecast, the upgrade alone won't lead to an interest rate hike if it is driven by temporary factors such as the rising price of rice and higher import costs, said three sources familiar with the bank's thinking.
The BOJ could hike rates this month if the board is convinced that sustained, broad-based wage hikes will take hold, and keep inflation durably at its 2% target, they said.
"Risks to inflation are skewed to the upside due partly to renewed yen falls," said one of the sources, a view echoed by another source.
"Wage momentum also appears to be strong," a third source said, adding the board may discuss revising up its inflation forecast for the fiscal year beginning in April.
The BOJ will likely debate whether to raise interest rates from the current 0.25% at its policy meeting on Jan. 23-24. It will also issue fresh quarterly growth and price forecasts that serve as the basis for setting monetary policy.
Under current forecasts, the board expects core consumer inflation to hit 1.9% for both fiscal 2025 and 2026. While the board has yet to discuss details of its forecasts, recent data and surveys have pointed to rising inflationary pressures.
The yen is currently hovering at 158 to the dollar, down from around 140 hit in September and near levels hit when the BOJ hiked rates in July last year.
Rising wages are adding to inflationary pressure, backing up the BOJ's argument that Japan is on track to sustainably achieve its 2% inflation target - a prerequisite for further rate hikes.
Wage hikes are spreading to companies of all sizes and sectors, the BOJ said in a quarterly report on Thursday, signaling that conditions for a near-term rate hike were continuing to fall into place.
"The need to raise pay is more widely shared among small firms," Kazushige Kamiyama, the BOJ's Osaka branch manager, told a news briefing on Thursday. "We can expect solid wage gains this year."
While such optimism heightens the chance of a rate hike at the BOJ's January meeting, Governor Kazuo Ueda has flagged uncertainty over U.S. President-elect Donald Trump's policy as a reason to tread cautiously in pushing up borrowing costs.
If comments and policies announced after Trump's inauguration on Jan. 20 trigger volatile market moves, the BOJ could put off hiking rates again, some analysts say.
Markets are focusing on BOJ Deputy Governor Ryozo Himino's speech and news conference on Tuesday, for fresh hints on whether the bank could hike rates this month.