Key points: Consumer inflation in Japan accelerated further in two of the three key readings in May, as largely expected, in the aftermath of rice supply shortages (regular rice prices double the year-earlier levels), partly offset by easing gasoline and utility costs as well as the year-long price-cutting effect of free high school education that began at a national level on April 1
--Core CPI (excluding fresh food) +3.7% y/y, the highest since +4.2% in January 2023 vs. +3.5% in April
--Total CPI +3.5% y/y vs. +3.6% in the previous two months, +4.0% in January; fresh food prices dipped (-0.1%) y/y after the recent spike caused by poor harvest, high import costs.
--Core-core CPI (ex-fresh food, energy) +3.3% y/y vs. +3.0%, the highest since +3.5% in January 2024

Takeaway: The current high inflation rate, neck and neck with Britain on top of the G7 list, is not backed by domestic demand (wage-heavy services price hikes lag behind goods price gains) but largely pushed up by higher import costs. This means that inflation in Japan is not accompanied by sustained and substantial wage growth and that underlying inflation, estimated by the Bank of Japan to be around 1.5%, just below the bank's 2% price stability target. The bank is in the process of normalizing its policy stance after a decade-long large-scale easing period through 2022 and is set to continue gradually raising the overnight interest rate from the current level of 0.5%. Officials argue that real borrowing costs remain"significantly negative" because the BOJ has been cautious about raising rates even when inflation expectations are rising moderately.

Key forecast points: core CPI (excluding fresh food) +3.6% y/y in May, the fastest in 28 months (since 4.2% in January 2023), vs. +3.5% in April in the aftermath of rice supply shortages, higher costs for utilities after three-month subsidies for electricity and natural gas ended in March for April bill payments; partly offset by the year-long price-cutting effect of free high school education that began at a national level on April 1; core-core CPI (excluding fresh food and energy) +3.2% vs. 3.0%; total CPI +3.5% vs. 3.6% as fresh vegetable prices have calmed after a recent spike.

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.