Consumer inflation in Tokyo, the leading indicator of the national average, eased further in December in line with forecasts as markups in food and beverages had already peaked, energy prices are on a downtrend and the recent surge in hotel fees on base-year effects slowed slightly, data from the Ministry of Internal Affairs and Communications released Tuesday showed.

The core CPI (excluding fresh food), which is closely watched by Bank of Japan policymakers, posted an 18-month low of a 2.1 percent rise on year, slowing from 2.3 percent in November and 2.7 percent in October. The year-over-year rise in the total CPI also slipped back to an 18-month low of 2.4 percent after easing to 2.7 percent (revised from 2.6 percent) in November from 3.2 percent in October.

The core-core CPI (excluding fresh food and energy) annual rate eased to a nine-month low of 3.5 percent from 3.6 percent in November, 3.8 percent in October, 3.9 percent in September and a 41-year high of 4.0 percent hit in August and July.

In its quarterly Outlook Report released in October, the BoJ board revised up its forecast for inflation for the current fiscal year further and jacked up its projection for fiscal 2024. It still sees inflation below its 2 percent target in fiscal 2025 ending March 2026. The bank will provide updates on its medium-terms growth and inflation projections as well as risk analysis later this month.

Econoday's Relative Performance Index stood at plus 18, above zero, which indicates the Japanese economy is performing better than expected after outperforming with a wider margin recently. Excluding the impact of inflation, the RPI was at plus 25.

Consumer inflation in Tokyo, the leading indicator of the national average, is forecast to ease further in December in all three key measures as markups in food and beverages had already peaked and subsidized energy prices are falling. By contrast, services costs have been rising on widespread labor shortages, a welcome signal for Bank of Japan policymakers who are seeking stable 2 percent inflation accompanied by sustainable wage hikes and with low risks of falling back into years of deflation.

The core CPI (excluding fresh food), which is closely watched by the BoJ, is expected to post an 18-month low of a 2.1 percent rise on year, slowing from 2.3 percent in November and 2.7 percent in October. The year-over-year rise in the total CPI is also seen falling to an 18-month low of 2.4 percent from 2.6 percent. The core-core CPI (excluding fresh food and energy) annual rate is expected to ease to a nine-month low of 3.5 percent from 3.6 percent the previous month.

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 Tokyo CPI data covers consumer prices in the capital’s 23 wards located in the eastern part of the Tokyo Prefecture but excludes the 26 cities and other smaller municipalities that occupy larger areas in other parts of the province (islands in the Pacific Ocean are also excluded). It is a leading indicator of the national average CPI as it is released about a month ahead of the national data. The survey for the Tokyo CPI is conducted on one day around the 12th (Wednesday, Thursday or Friday) each month and its results are released toward the end of the same month or early in the following month.

The national CPI has a larger energy weight of 712 out of 10,000, compared to 470 in the Tokyo data, because the shares of consumption of electricity, gasoline and heating oil tend to be bigger in the rural areas. There is only a slight difference in the weighting of food excluding perishables between the national data (2,230) and the Tokyo data (2,144).

The CPI has been in the spotlight as Japan struggled to make its way out of deflation. It is now closely monitored because the recent spike in energy and commodity markets and supply chain constraints during the global pandemic boosted Japan’s inflation rate to the highest in over four decades in 2022.

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.