Consumer inflation in Japan eased back to just above 3 percent in May in both the total and core indexes as utility and gasoline subsidies continued to cap already easing energy costs while widespread markups for processed food pushed up the narrow measure to a fresh 41-year high, data from the Ministry of Internal Affairs and Communication released Friday showed.

Energy prices fell further also because the government lowered the renewal energy promotion surcharge on electricity bills for fiscal 2023, effective in April, which was reflected in bills due in May.

The Bank of Japan's policy board maintained its monetary easing stance at its meeting on June 15-16, keeping its zero to slightly negative interest rate targets along the yield curve and large asset purchases to guide inflation toward the stable 2 percent target with sustained wage growth.

The Econoday Consensus Divergence Index stands at zero, which indicates the Japanese economy is performing as expected after having underperformed in recent weeks. Excluding the impact of inflation, the index is also at zero.

The national average core consumer price index (excluding fresh food) rose 3.2 percent from a year earlier in May, slightly firmer than the median economist forecast for a 3.1 percent rise. It is the 21st straight year-over-year increase after rising 3.4 percent in April, 3.1 percent in both March and February (the first deceleration in 13 months), 4.2 percent in January and 4.0 percent in December.

The 4.2 percent rise in January is a 41-year high, the largest increase since the 4.2 percent gain in September 1981, with or without the direct impact of the sales tax hikes in 2014 (from 5 percent to 8 percent) and in 1997 (from 3 percent to 5 percent) and the introduction of the sales tax in 1989. The tax was further raised to 10 percent in 2019 but had only a limited impact on prices.

Service prices in Japan have moved up in recent months as more firms are raising wages to secure workers, although the average cash earnings per employee are falling in real terms. Service prices excluding owners' equivalent rent rose 2.5 percent on the year in May, up from a 2.4 percent increase in April. Goods prices excluding fresh food gained 4.6 percent, slowing from a 5.1 percent rise the previous month.

Bank of Japan's policy board has projected that the increase in the core CPI would slow to 1.8 percent in fiscal 2023 from 3.0 percent in fiscal 2022 that ended in March as the base effects of last year's spike in energy and commodities prices fade. For fiscal 2024, the board expects the core reading to rise 2.0 percent, noting the impact of government subsidies to cap retail gasoline and utility prices will wane. But its forecast for 2025 is a lower 1.6 percent, indicating the banks' battle to reflate the economy may be prolonged.

The underlying inflation rate -- measured by the core-core CPI (excluding fresh food and energy) -- rose to a fresh 41-year high of 4.3 percent on year in May, accelerating further from 4.1 percent in April, 3.8 percent in March and 3.5 percent in February. It was the 14th straight year-over-year increase and just above the median economist forecast for a 4.2 percent rise. The 4.3 percent rise is the largest since the 4.5 percent increase June 1981. This narrow measure is without the effects of energy cost fluctuations. It has been pushed up by markups in various items including processed food.

The total CPI rose an as-expected 3.2 percent on year in May, marking the 21st consecutive year-over-year increase, after rising 3.5 percent in April, 3.2 percent in March, 3.3 percent in February and 4.3 percent in January. Fresh food prices, a volatile factor, rose 5.2 percent on year and pushed up the overall index by 0.22 percentage point after rising 5.3 percent (up 0.22 point) the previous month. The 4.3 percent increase January's total CPI is a 41-year high, the largest since the 4.3 percent rise in December 1981.

Among key components of the CPI basket of goods and services, energy prices slumped 8.2 percent on year in May, pushing down the CPI by 0.69 percentage point, after falling 4.4 percent with a negative 0.37-point contribution to April, falling 3.8 percent (minus 0.32 point) in March and dipping 0.7 percent (minus 0.06 point) in February, which was the first drop since March 2021.

The government has contained retail gasoline prices by providing subsidies to refineries. It also began providing subsidies for electricity and natural gas in January (reflected in February bills onward) and the program will continue through September. In addition, the government lowered the renewal energy promotion surcharge on electricity bills to ¥1.40 per kilowatt-hour for fiscal 2023, effective in April, from ¥3.45 in fiscal 2022. The official estimate is that a typical household that uses about 400 kilowatt-hours will pay around ¥820 less per month, or an annual decrease of ¥10,000.

Gasoline prices fell 1.7 percent on year in May, making a negative 0.04 percentage point contribution to overall consumer prices, after falling 3.3 percent with a negative 0.08 percentage point contribution in March.

Electricity charges dropped 17.1 percent (minus 0.69 point) in May after falling 9.3 percent (minus 0.36 point) in April, 8.5 percent (minus 0.32 point) in March and 5.5 percent (minus 0.21 point) in February, the first drop since July 2021, after rising 20.2 percent (plus 0.75 point) in January. The year-over-year increase in city gas prices continued slowing to 1.4 percent (plus 0.02 point) after rising from 5.0 percent (plus 0.06 point) in April, 10.0 percent (plus 0.11 point) in March, 16.6 percent (plus 0.17 point) in February and 35.2 percent (plus 0.35 point) in January.

The prices for food excluding perishables, which has a large weight in the CPI basket, posted the 23rd straight year-over-year increase, up 9.2 percent (plus 2.07 points) after rising 9.0 percent (plus 2.02 points) in April. It is the largest increase in more than 46 years, since the 9.9 percent surge in October 1975. Sharp price hikes were seen among many items including prepared food (fried chicken), eating out (hamburgers), snacks (chocolate) and soft drinks.

The prices for household durable goods (air conditioners, etc.) marked the 14th consecutive gain from year-earlier levels. The pace of increase decelerated to 9.0 percent (plus 0.13 point) from 9.8 percent (+0.14 point) in April.

Accommodations, which have a relatively small weight in the CPI basket of goods and services, rose 9.2 percent in May, raising the CPI's year-on-year increase by 0.0.9 percentage point in May, thanks to strong reopening demand for traveling and despite slight downward pressure from travel subsidies. Hotel fees rose 8.1 percent on the year in April, with a positive 0.08-point contribution, after slipping 0.6 percent with the a negative 0.01-point contribution in March.

Consumer inflation in Japan is expected to ease back to just above 3% in May in both the total and core indexes as utility and gasoline subsidies continued to cap already easing energy costs. The government also lowered its renewal energy promotion surcharge on electricity bills for fiscal 2023, effective in April, which was reflected in bills due in May.

The closely watched core CPI, which excludes fresh food prices, is forecast to post a 3.1 percent rise on the year after rising 3.4 percent in April and 3.1 percent in March while the annual rate in the total CPI is seen slowing to 3.2 percent from 3.5 percent in April to match March's 3.2 percent.

By contrast, widespread markups for processed food are expected to push up the increase in the core-core CPI (excluding fresh food and energy) to a fresh 41-year high of 4.2 percent from April's 4.1 percent.

The Consumer Price Index (CPI) is a measure of the average price level of a fixed basket of goods and services purchased by consumers. Annual changes in the CPI represent the rate of inflation.

The CPI has been in the spotlight as Japan struggled to make its way out of deflation. The report tracks changes in the price of a basket of goods and services that a typical Japanese household might purchase. The preferred measure is the year over year percent change. Markets will typically pay more attention to the core measure that excludes only fresh food because volatile food prices can distort overall CPI. A second core measure that excludes energy as well is also available. As the most important inflation indicator, the CPI data are closely monitored by the Bank of Japan. Rising consumer prices may prompt the BoJ to raise interest rates in order to manage inflation and slow economic growth. Higher interest rates make holding the yen more attractive to foreign investors, and this higher level of demand will place upward pressure on the value of the yen.

An investor who understands how inflation influences the markets will benefit over those investors that do not understand the impact. Inflation is an increase in the overall prices of goods and services. The relationship between inflation and interest rates is the key to understanding how indicators such as the CPI influence the markets and your investments.

Inflation (along with various risks) basically explains how interest rates are set on everything from your mortgage and auto loans to government securities. As the rate of inflation changes and as expectations on inflation change, the markets adjust interest rates. The effect ripples across stocks, bonds, commodities and your portfolio, often in a dramatic fashion.

By tracking inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform. Over the long run, the bond market will rally (fall) when increases in the CPI are small (large). The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.