Consumer inflation in Japan accelerated in two of three key measures in May as the government raised the renewable energy charge that users pay for greener electricity but the largest contribution to the year-over-year increase in the CPI remains processed food prices.

The core CPI (excluding fresh food prices), closely watched by the Bank of Japan for its policy stance, rose 2.5 percent on year in May after rising at a three-month low of 2.2 percent in April and 2.6 percent in March, coming in slightly below the consensus call of a 2.6 percent increase. The year-over-year increase in the total CPI rose to a three-month high of 2.8 percent after easing to 2.5 percent in April from 2.7 percent in March. It was also below the median forecast of a 2.9 percent rise.

Underlying inflation measured by the core-core CPI (excluding fresh food and energy) decelerated to a 20-month low of 2.1 percent from 2.4 percent, also just under the median forecast of a 2.2 percent rise. The annual rate for this narrow indicator had been at or above 3.0 percent from December 2022 until February 2024.

Overall energy prices jumped 7.2 percent on year in May, pushing up the CPI by 0.54 percentage point, after edging up 0.1 percent with a slightly positive 0.01-point contribution in April. Food prices excluding perishables continued to ease to a 3.2 percent increase from 3.5 percent but this category remains the largest contributor, raising the CPI by 0.76 point, although it is smaller than plus 0.83 point seen the previous month.

Services costs have led overall inflation until recently as firms raise wages at a faster pace to secure qualified workers amid widespread labor shortages. Service prices excluding owners' equivalent rent rose 2.2 percent on the year in May, pushing up the total CPI by 0.71 percentage point, following a 2.5 percent rise (plus 0.79 point) in April. Goods prices excluding fresh food gained 3.5 percent (plus 1.69 points), rising sharply from a 2.6 percent (plus 1.28 point) as utility costs showed a hefty increase in May after falling for months.

In coming months, the BOJ board is expected to"cautiously" raise the overnight interest rate target gradually. At its latest meeting on June 13-14, the nine-member board decided in a unanimous vote to hold the overnight interest rate target steady in a range of 0 percent to 0.1 percent for the second straight meeting after conducting its first rate hike in 17 years and ending the seven-year-old yield curve control framework in March. At the same time, the board decided in an 8 to 1 vote to set the stage for gradually reducing the bank's large holdings of various financial assets for the next year or two years"to ensure long-term interest rates would be formed more freely in financial markets." It will work out a specific plan at its July 30-31 meeting after bank officials have compared notes with market participants.

Econoday's Relative Performance Index stands at minus 11, below zero, which indicates the Japanese economy is performing slightly worse than expected. Excluding the impact of inflation, the RPI is at minus 9. This is unlikely to shop the BoJ from continuing its policy normalization process after more than a decade of large-scale easing aimed at turning around the deflationary mindset.

Consumer inflation in Japan is expected to rise in two of three key measures in May as the government raised the renewable energy charge that users pay for greener electricity purchased by utilities.

The core CPI (excluding fresh food prices) is forecast to rise 2.6 percent on year in May after rising at a three-month low of 2.2 percent in April, down from 2.6 percent in March. The year-over-year increase in the total CPI is forecast at a seven-month high of 2.9 percent after slowing to 2.5 percent from 2.7 percent. Underlying inflation measured by the core-core CPI (excluding fresh food and energy) is expected to ease further to a 20-month low of 2.2 percent from 2.4 percent in April.

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.