Stocks soar on Nvidia earnings, Samsung strike suspension By Leika Kihara FUKUOKA, Japan, May 21 (Reuters) - The Bank of Japan should raise interest rates at an "appropriate pace" as price pressures from the Middle East war may push underlying inflation above its 2% target, its board member Junko Koeda said, bolstering the case for a rate hike as soon as June. The former academic also said the central bank must pay more attention to the side-effects of keeping real interest rates negative, as oil prices may remain high for a prolonged period. "Given the situation in the Middle East, I see some possibility that underlying inflation may exceed 2% looking ahead," Koeda said on Thursday, adding that recent slight rises in long-term inflation expectations warranted attention. "I believe it’s reasonable to raise the policy interest rate at an appropriate pace to address high inflation while also considering the trade-offs for the economy," she said. The remarks suggest Koeda may join hawks in the board in calling for a rate increase, which would heighten the chance of a rate hike at the BOJ’s next meeting on June 15-16. The BOJ keeps its short-term policy rate at 0.75% even as core consumer inflation exceeds its 2% target for four years. Koeda said the BOJ must be mindful of the demerits of keeping inflation-adjusted real interest rates well below levels deemed neutral to the economy, such as causing unintended distortions in future resource allocation. Given Japan’s positive output gap and strong global IT demand, Japan’s economy is likely to avert a major economic downturn in coming years, Koeda said in her speech to business leaders in the southern Japanese city of Fukuoka. "If the economy does not see a major downturn, more attention must be paid to the side-effects of a further decline in real interest rates," she said. Koeda’s remarks follow those by another board member Kazuyuki Masu, who last week called for raising rates as soon as possible if there are no clear signs of an economic slowdown. The recent slew of hawkish BOJ signals has led markets to price in roughly a 70% chance of a rate hike in June. Nearly two-thirds of economists polled by Reuters also expect the BOJ to raise rates next month. At the April 27-28 meeting, the BOJ kept its short-term policy rate steady at 0.75%. But three board members dissented, instead calling for a hike in a sign of mounting concern over inflationary pressures from the Iran war. If Masu and Koeda join the three hawkish dissenters, that means mean five in the nine-member board would favour a rate rise, and could outnumber doves favouring keeping rates steady. OIL RISE MAY PERSIST The BOJ ended a decade-long, massive stimulus in 2024 and raised rates several times including in December on the view Japan was on the cusp of durably hitting its 2% inflation goal. The Middle East conflict has complicated the BOJ’s task, as higher energy costs fuel inflation while simultaneously squeezing an economy heavily dependent on oil imports. Koeda said underlying inflation is already around 2% with companies passing on costs through price hikes at a faster pace than in the past. Normalising monetary policy through rate hikes would become even more important if inflation and public perceptions of future prices heighten further, Koeda said. "Developments over the past month or two may have increased the likelihood of a risk scenario in which high crude oil prices persist," she said, suggesting that the rise in energy costs stemming from the Middle East may not prove temporary. Strong AI demand may also be contributing to higher energy prices, which could mean prices may increase across a wide range of items down the road, she added.