The Bank of Japan kept interest rates on hold at 0.5 per cent in a unanimous vote on today, as widely expected, as it balanced concerns about rising inflation with a worsening economic outlook.
While the BOJ, like other central banks, is worried about inflation from soaring raw materials costs, it sees little need to shift to a tightening bias for now as the economy is hardly overheating and inflation is not spreading much beyond food and energy prices.
Nevertheless, wholesale prices are rising nearly five times as fast as consumer inflation, squeezing companies that have led Japan's recent growth.
Investors are thus focusing on whether BOJ Governor Masaaki Shirakawa will join his counterparts in the United States and Europe in stepping up inflation warnings.
"The risk of stagflation is increasing with inflation accelerating even as the economy weakens," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute.
Rising commodity prices have swung the main focus of global policy-makers in recent weeks away from economic growth to the threat of a global spike in inflation.
Federal Reserve Chairman Ben Bernanke signalled this week that the US central bank would act to strongly resist rising inflation, while European Central Bank President Jean-Claude Trichet said rates might rise as soon as July.
The global threat of inflation is also expected to take centre stage at this weekend's meeting of Group of Eight finance ministers, although measures to tackle it look elusive.
The hawkish remarks by Fed and ECB officials have heightened market expectations that the BOJ will follow in their footsteps and hike rates later this year, although many economists expect no action at least until early next year.