Key points: All as expected, high inflation is hurting households whose main rice earners see real wages fall for the seventh straight month in June (revised labour survey just out total monthly average cash earnings per regular employee were up 3.1% vs initial +2.5% but wages after adjusted for inflation slipped 0.8% vs. prelim -1.3%)
--Consumer inflation in Japan eased further in July to just above 3% in two key measures, thanks to retail gasoline subsidies which has offset the continued uptick in processed food costs. The yen's rise from last year's slump has also lowered import costs and sparked a pullback in spending by visitors from overseas who lost their currencies' competitive edge over the yen.
--The core reading (excluding fresh food) posted a 3.1% rise on year in July after its annual rate decelerated to 3.3% in June from 3.7% in May. The year-on-year rise in the total CPI also moderated to 3.1% from 3.3% in June and 3.5% previously. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) stood at 3.4% after rising to a 17-month high of 3.4% from 3.3%.
--The impact of slowing overall energy price gains (gasoline has been down) was mitigated by elevated processed food prices despite gradually easing domestic rice supply shortages. Regular rice prices rose as high as 90% y/y but that is slightly lower than over 100% (double) earlier this year. The prices of chocolate remain high, up 51%, while those of coffee beans climbed 44%.

Takeaway:
The current high inflation rate is not fully 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:
--Consumer inflation in Japan is expected to ease further in July to just above 3% in key measures, thanks to retail gasoline subsidies and the yen’s rise from last year’s slump that has lowered import costs and sparked a pullback in spending by visitors from overseas who lost their currencies competitive edge against the yen. The impact of slowing overall energy price gains (gasoline is down) was mitigated by elevated processed food prices despite gradually easing domestic rice supply shortages.
--The core reading (excluding fresh food) is forecast to post a 3.1% rise on year in July after its annual rate decelerated to 3.3% in June from 3.7% in May. The year-on-year rise in the total CPI is also seen at 3.1%, easing further from 3.3% in June and 3.5% the prior month. The underlying inflation measured by the core-core CPI (excluding fresh food and energy) is estimated at 3.4% after rising to a 17-month high of 3.4% from 3.3%.

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.