Bank of Japan Warns AI Boom Could Trigger Market Correction If Profits Fail to Materialize

Bank of Japan Flags AI Boom's Dual Impact on Financial Conditions

The Bank of Japan is closely examining how the AI boom may have eased financial conditions while simultaneously creating new market risks. Deputy Governor Shinichi Uchida stated in a speech published on the central bank's website on Monday that worldwide AI adoption represents "a big positive demand shock, which has put upward pressure on the economy and prices."1

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The technology's rapid spread has boosted demand and lifted asset prices, making financial conditions more accommodative overall. However, Uchida warned that markets could face a significant pullback if anticipated AI-related profits fail to materialize, highlighting the precarious balance between current valuations and future returns.

AI's Possible Impact on Neutral Rate Remains Uncertain

Uchida's comments suggest the AI boom could fundamentally alter Japan's natural rate of interest, though the overall effect remains difficult to gauge. The technology could raise productivity and enhance capital stock accumulation, potentially influencing what economists call R-star—the rate of interest that neither stimulates nor restrains the economy before adding inflation.3

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"We don't have a clear answer yet," Uchida acknowledged, noting that the BOJ will continue to carefully examine economic and financial data to ascertain a "consistent picture" on AI's impact.1

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The initial impact appears to have come from the demand side, but the longer-term structural implications could push monetary policy in conflicting directions.

Market Correction Risk Looms If AI-Related Profits Disappoint

The Bank of Japan Deputy Governor warned that the AI boom could trigger market correction if there's a mismatch between elevated asset valuations and the profits ultimately generated by AI-related investments. "Tentatively, it appears the demand side has come first and made financial conditions more accommodative on balance. But there is a risk of correction if profits do not follow," Uchida stated.2

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While rising stock prices linked to AI have helped ease financial conditions, the situation presents a contrasting dynamic. Huge bond issuance by AI-related firms has put upward pressure on long-term interest rates, creating tighter conditions in debt markets.4

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Inflationary Pressure and Monetary Tightening Considerations

The Bank of Japan has identified robust AI-related demand as among factors that could push underlying inflation above its 2% target, potentially necessitating further monetary tightening. The central bank raised interest rates in June and September, bringing the policy rate to 1.25%, and is widely expected to hike again before the end of the year.3

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These rate increases came as the energy shock caused by the Iran war added to inflationary pressure from a weak yen, which increases import costs. Japan imports almost all of its crude oil, with most supplies coming from the Middle East before the closure of the Strait of Hormuz, leaving the economy particularly exposed to regional energy market disruptions.1

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Structural Impacts on Labor Markets and Social Inequality

Beyond immediate market risks, Shinichi Uchida highlighted potential longer-term structural changes from AI adoption. "AI could rapidly make certain forms of human capital obsolete, particularly skills that were designed for intellectual labor," he noted.3

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The technology may also affect social inequality, as people with more technological skills and flexibility could gain far more benefits than others. These conflicting impacts require careful examination as central banks across the world assess how quickly and how far to adjust monetary policy. The demand shock from AI is fueling both economic growth and inflationary pressure, while productivity gains could eventually moderate price increases—creating a complex picture for policymakers navigating this technological transformation.