Consumer inflation in Japan accelerated in all three key measures in January, with the core reading (excluding fresh food) rising further to a 20-month high of 3.2% from 3.0% in December (vs. consensus +3.1%), temporarily overshooting above the Bank of Japan's price stability target of 2%. Protracted domestic rice shortages boosted the prices for processed food further (regular rice prices up 71.8% y/y), the weak yen pushed up import costs (chocolate +30.8%, coffee beans +23.7%) and the plunge in temperatures triggered strong demand for heat pumps and other appliances. Retail gasoline prices continued rising on reduced subsidies while utility costs remained elevated after the government ended its temporary subsidies late last year.

The year-on-year increase in the total CPI surged to a two-year high of 4.0% after rising to 3.6% in December from 2.9% in November, which was also pushed up by higher fresh food prices (cabbage up a whopping 192.5% on bad weather, tangerines up 37.0%). The underlying inflation measured by the core-core CPI (excluding fresh food and energy) stood at 2.5% after being unchanged at 2.4% previously and hitting its 10-month high.

The CPI increase was led by the prices of processed food +5.1% y/y (+1.24 point contribution) in January vs. +4.4% (+1.06 points) in December as well as the costs for overall energy +10.8% (+0.82 point) vs. +10.1% (+0.76 point). Land line charges were flat on year but up from December, when they slumped 12.1% (-0.06 point), working as a factor to push up the CPI. Compared with December, the y/y upward pressure difference of plus 0.18 point just coming from the processed food was canceled out by the downward pressure of the minus 0.18 point gap from overseas traveling amid heightened geopolitical risks. The costs for overseas tours packaged in Japan rose a meager 1.9% on year in January (+0.01 point contribution), down sharply from a 74.7% jump (+0.18 point) in the prior month.

Services costs minus owners' equivalent rent rose 1.9% on year, losing more steam after rising 2.3% the previous month, while goods prices minus fresh food increased at a much higher pace of 4.9%, up from +4.3%. This underscores the poorer quality of life for many households as wage growth still lags behind the pace of increase in the costs of living, and thus it needs to accelerate further to anchor inflation in a sustainable manner, instead of drifting downward to stoke deflationary fears.

The Bank of Japan, which expects inflation to be anchored around its 2% target by early 2026, is on course for two more 25 basis point rate hikes that would take the overnight interest rate target to 1% by late 2025 or early 2026 as part of its gradual normalization process after more than a decade of large-scale easing.

Consumer inflation in Japan is expected to accelerate further in all three key measures in January, with the core reading (excluding fresh food) seen up a 17-month high of 3.1% on year after rising to 3.0% in December from 2.7% in November. Protracted domestic rice shortages boosted the prices for processed food, the weak yen pushed up import costs and the plunge in temperatures triggered strong demand for heat pumps and other appliances. Gasoline prices rose and utility costs remained elevated after the government ended its temporary subsidies late last year.

The year-on-year increase in the total CPI is forecast at a 24-month high of 3.9%, also up from 3.6% the previous month. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) is seen at a 10-month high of 2.5% after being unchanged at 2.4% previously.

The Bank of Japan, which expects inflation to be anchored around its 2% target by early 2026, is on course for two more 25 basis point rate hikes that would take the overnight interest rate target to 1% by late 2025 or early 2026 as part of its gradual normalization process after more than a decade of large-scale easing.

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.