Consumer inflation in Tokyo came in firmer than expected but that doesn't mean the Bank of Japan will have to raise interest rates at a faster pace as its policy stance is linked to medium-term inflation expectations, not short-term results.

The core CPI (excluding fresh food) rose 2.4 percent on year, just above the consensus call of a 2.3 percent increase, following a 2.2 percent gain in July. The government ended its 18-month-long subsidies in June for July bill payments while dangerously high temperatures of around 40 degrees Celsius boosted prices for air conditioners.

A surge in fresh food prices drove the year-over-year rise in the total CPI to 2.6 percent from July's 2.2 percent as the heat wave has caused an unusual short supply of rice, leading to the sharpest price markup for the primary staple in 20 years. The annual rate for the core-core CPI (excluding fresh food and energy) crept up to 1.6 percent from 1.5 percent in July as the costs for processed food markups picked up again after easing in recent months.

Consumer inflation in Tokyo, the leading indicator of the national average, is forecast to stay on a gradual uptrend in the core reading (only fresh food is excluded) in August after the government ended its 18-month-long subsidies in June for July bill payments and dangerously high temperatures around 40 degrees Celsius in many cities boosted the prices for air conditioners. The core CPI (excluding fresh food), closely watched by the Bank of Japan, is expected to post a 2.3 percent increase on year after creeping up to 2.2 percent in July from
2.1 percent in June.

The year-over-year rise in the total CPI is forecast to move up to 2.4 percent from July's 2.2 percent as the kill heat wave have caused an unusual short supply of rice, leading to the sharpest markup for the primary staple in 20 years. The annual rate for the core-core CPI (excluding fresh food and energy) is seen at 1.4 percent, down from 1.5 percent in July and 1.8 percent in June, thanks to easing upward pressures from processed food prices.

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.