Consumer inflation in Japan picked up in two of the three key readings in March, driven by faster year-on-year rises in the prices for processed food in the aftermath of rice shortages and in hotels fees due to an influx of visitors from overseas who are taking advantage of the weak yen. Those factors more than offset the slight price-cooling impact of temporary utility subsidies aimed at lowering electricity and natural gas bills during the peak heating season from January to March (bills paid from February to April).

The core reading (excluding fresh food) posted a 3.2% increase on year after easing to 3.0% in February from 3.2% in January. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) firmed to 2.9% from 2.6% previously. By contrast, the year-on-year rise in the total CPI unexpectedly eased further to 3.6% in light of slower gains in fresh food prices after decelerating to 3.7% in February from a two-year high of 4.0% at the start of the year.

In fiscal 2024, the core CPI rose 2.7% on year, slightly easing from 2.8% in fiscal 2023 and 3.0% in fiscal 2022 while recovering from the pandemic-caused deflationary years of fiscal 2021 (+0.1%) and fiscal 2020 (-0.4%, the first drop in four years). The key inflation indicator is edging closer to Bank of Japan's 2% price stability target. The bank expects inflation to be anchored around the target by early 2026,

At its next meeting on April 30-May 1, the BOJ's nine-member board is expected to remain cautious amid high uncertainty over a global trade war that has already hurt sentiment among large manufacturers, after having decided unanimously to maintain the target for overnight interest rate at 0.5% in March. Previously, the panel voted 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 high wage increases by major firms will spread to smaller firms in fiscal 2025 that began 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 tick up in two of the three key readings in March, driven by faster year-on-year rises in the prices for processed food on protracted rice shortages, heaters amid severe winter weather and hotels due to an influx of visitors from overseas who are taking advantage of the weak yen. Those factors are seen more than offsetting the slight price-cooling impact of temporary utility subsidies aimed at lowering electricity and natural gas bills during the peak heating season from January to March (bills paid from February to April).

The core reading (excluding fresh food) is forecast to post a 3.3% increase on year after easing to 3.0% in February from 3.2% in January. The year-on-year rise in the total CPI is also expected to firm to 3.8% after easing to 3.7% from a two-year high of 4.0% at the start of the year. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) is estimated at 2.9% vs. 2.6% previously.

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.

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.