Japanese inflation data released today showed a headline inflation and measures of underlying inflation moderated in June but remained well above the Bank of Japan's 2.0 percent inflation target. At their most recent meeting, held last month, BoJ officials left policy settings on hold, reflecting their assessment that inflation is still likely to settle around the target in the second half of the projection period (fiscal 2025 through fiscal 2027).

The headline consumer price index rose 3.3 percent on the year in June, down from an increase of 3.5 percent in May, and fell 0.1 percent on the month in seasonally adjusted terms after advacning 0.3 previously. This fall in headline inflation in June reflects offsetting moves in major components. The fall in headline inflation was largely driven by a smaller increase in fuel, light and water charges, up 3.4 percent on the year after a previous increase of 7.7 percent, and prices of household durable goods, yop 2.5 percent after a previous increase of 3.8 percent. Food price inflation, in contrast, picked up from 6.5 percent in May to 7.2 percent in June.

Core CPI, which excludes fresh food prices, rose 3.3 percent on the year in June, down from 3.7 percent in May and just below the consensus forecast of 3.4 percent. The index was flat on the month after advancing 0.4 percent previously. The Bank of Japan's preferred measure of underlying inflation, the year-over-year change in CPI excluding fresh food and energy prices, picked up slightly from 3.3 percent to 3.4 percent, with this index increasing 0.2 percent on the month after a previous increase of 0.3 percent.

Key forecast points:
--Consumer inflation in Japan is expected to ease in two of the three key measures in June thanks to renewed subsidies to cap retail gasoline and heating oil prices but still above 3% amid high processed food prices, temporarily exceeding the Bank of Japan’s long-run 2% price stability target. The pace of deceleration is unlikely to be so drastic as in the Tokyo CPI data released last month. The metropolitan area saw a plunge in water bills due to the metropolitan government’s free base charge for four months that began in June.
--Core CPI (excluding fresh food) +3.4% y/y in June vs. +3.7% in May; Upward pressure on processed food prices in the aftermath of rice supply shortages is partly offset by slower gains in energy costs and the year-long price-cutting effect of free high school education that began on April 1; core-core CPI (excluding fresh food and energy) +3.4% vs. +3.3%; total CPI +3.3% vs. +3.5% as fresh vegetable prices have stabilized after an earlier 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.