Consumer inflation in Japan continued easing in January but not so fast as expected as downward pressures from falling subsided energy costs, smaller processed food markups and hotel fee gains were partly offset by a surge in overseas package tour prices due to a statistical distortion and higher auto insurance premiums.

The core CPI (excluding fresh food prices), the key measure for the Bank of Japan to assess whether inflation is anchored around its 2 percent target, rose 2.0 percent on the year (versus the consensus call of a 1.9 percent rise). The increase was led by easing but still relatively high processed food prices and rising service costs amid widespread labor shortages. It was the smallest rise in 22 months and followed a 2.3 percent gain in December.

The year-over-year increase in the total CPI also slowed to a 22-month low of 2.2 percent, after easing to 2.6 percent in December from 2.8 percent in November , but it was slightly above the consensus forecast of 2.0 percent. Underlying inflation measured by the core-core CPI (excluding fresh food and energy) decelerated to an 11-month low of 3.5 percent from 3.7 percent, coming in above the median forecast of a 3.3 percent rise.

Inflation has eased back to the period just before the world felt the full impact of heightened geopolitical risks. Russia's invasion of Ukraine in late February 2022 triggered a spike in energy and commodities prices in the following months. Global supply chain constraints at the time also boosted import costs for Japan, which was aggravated by the weak yen.

But that shouldn't stop BoJ policymakers from seeking an exit from the current policy framework. With consumer prices more stable, they can start unwinding large-scale monetary stimulus without causing much disruption this year when they can confirm clearer signs of sustained wage hikes in fiscal 2024 starting in April.

Service costs rose at a faster pace than goods prices for the third month in a row as firms have been raising wages to secure workers amid widespread labor shortages. Service prices excluding owners' equivalent rent rose 3.2 percent on the year in January, pushing up the total CPI by 1.00 percentage point, only slightly slower than a 3.3 percent rise (plus 1.04 points) in December. By contrast, goods prices excluding fresh food gained 1.9 percent (plus 0.93 points), slowing clearly from a 2.3 percent increase (plus 1.12 points).

Despite easing price pressures, many households have seen their spending power eroded by inflation. The pickup in nominal wages continued for two years in December but real wages fell on the year for the 21st straight month.

The weakness in consumer spending amid high costs was reflected in Econoday's Relative Performance Index. It stood at minus 13, below zero, which indicates the Japanese economy is performing slightly worse than expected. Excluding the impact of inflation, the RPI was at minus 37.

Consumer inflation in Japan is expected to continue easing in January as food price markups slowed after peaking earlier, utility subsides continued to trim energy bills and hotel charges slowed sharply after their recent surge on base-year effects. Stable prices will help Bank of Japan policymakers begin unwinding large-scale monetary stimulus when they can confirm sustained wage hikes in fiscal 2024 starting in April.

The core CPI (excluding fresh food prices), the key measure for the BoJ to assess whether inflation is anchored around its 2 percent target, is forecast to have risen 1.9 percent on the year, led by easing but still high processed food prices and rising service costs amid widespread labor shortages. It would be the smallest rise in 22 months and follow a 2.3 percent gain in December. The year-over-year increase in the total CPI is also seen slowing to a 22-month low of 2.0 percent from 2.6 percent. Underlying inflation measured by the core-core CPI (excluding fresh food and energy) is expected to have decelerated to a 12-month low of 3.3 percent from 3.7 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.