Consumer inflation in Japan eased in two of the three key readings in February but came in somewhat firmer than expected as severe winter weather boosted demand for heat pumps and the government's emergency release of rice stockpiles failed to bring down the prices of the national staple. Energy costs have been brought down temporarily by utility subsidies for electricity and natural gas during the peak heating season from January to March (bills paid from February to April). By contrast, processed food prices rose at a faster pace in the aftermath of protracted domestic rice supply shortages and high import costs caused by the weak yen.

The core reading (excluding fresh food) posted a 3.0% increase on year (consensus +2.9%), easing from January's 3.2% gain, which was the fastest pace in 21 months. The year-on-year rise in the total CPI also decelerated to 3.7% (consensus +3.5%) after surging to a two-year high of 4.0% the previous month. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) stood at 2.6%, up from 2.5% previously as forecast.

The Bank of Japan, which expects inflation to be anchored around its 2% target by early 2026, is believed to be 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.

Governor Kazuo Ueda told a news conference on Wednesday that he will keep in mind heightened upside risks to inflation warned about by some BOJ board members at the latest two-day meeting among other things when he formulates monetary policy. The underlying inflation is estimated to be still under 2%, the governor said. To put it simply, the price increase in service prices is not so strong, he said, underscoring the slow progress in lifting regulated wages as well as underpaid workers at restaurants and tourism. Ueda said the BOJ would not raise its policy rate just to contain a spike in the prices of rice in the aftermath of acute domestic supply shortages because that would cool off consumption.

At its March 18-19 meeting, the BOJ's nine-member board voted unanimously to maintain the target for overnight interest rate at 0.5%, as widely expected, after voting 8 to 1 to raise the policy rate by another 25 basis points to 0.5% in January in a third rate hike during the current normalization process that began in March 2024. Members are closely monitoring whether expected high wage increases by major firms will spread to smaller firms in fiscal 2025 starting on April 1 at a time when real wages are falling, which could hurt consumption further and generate deflationary pressures.

Consumer inflation in Japan is expected to ease a few notches in two of the three key readings in February as the government has revived temporary utility subsidies to help lower electricity and natural gas bills during the peak winter heating season from January to March (bills paid from February to April). However, processed food prices remain elevated in the aftermath of protracted domestic rice supply shortages and high import costs caused by the weak yen.

The core reading (excluding fresh food) is forecast to post a 2.9% increase on year, easing from January’s 3.2% gain, which was the fastest pace in 21 months. The year-on-year rise in the total CPI is also expected to decelerate to 3.5% after surging to a two-year high of 4.0%
the previous month. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) is estimated at 2.6% vs. 2.5% 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.