Japan’s core inflation accelerated in May due to increased energy levies, but an index excluding fuel slowed for the ninth consecutive month, according to data released on Friday. This presents a challenge for the Bank of Japan in deciding when to raise interest rates. The slowdown in “core core” inflation, a key measure of demand-driven price movements closely monitored by the Bank of Japan, casts doubt on the central bank’s belief that rising wages will sustain consumption and help achieve the 2% inflation target.
The core consumer price index (CPI), which excludes volatile fresh food, rose by 2.5% in May compared to the previous year, up from a 2.2% increase in April. This rise was mainly due to a hike in the renewable energy levy. The result was close to market expectations of a 2.6% increase. However, inflation measured by an index that excludes both fresh food and fuel slowed to 2.1% in May from 2.4% in April, marking the lowest year-on-year increase since September 2022. Inflation in the private-sector services slowed to 2.2% in May from 2.4% in April, indicating that companies remain hesitant to pass on labor costs to consumers.
Marcel Thieliant, head of Asia-Pacific at Capital Economics, noted that the anticipated boost to services inflation from strong wage hikes has not yet materialized. Rising crude oil prices and increased import costs due to a weak yen complicate the inflation outlook. Analysts predict that core CPI could approach 3% later this month because of rising raw material costs. However, this pressure could hurt consumption and deter companies from raising prices, undermining the BOJ’s efforts to maintain stable, demand-driven inflation around its 2% target.
Takeshi Minami, chief economist at Norinchukin Research, pointed out that real wage growth remains weak, and there is no data confirming an acceleration in demand-driven inflation. He suggested that the BOJ might not raise rates until at least the fourth quarter of this year. The BOJ abandoned negative rates and bond yield control in March, signaling a significant shift from its decade-long, radical stimulus program. With inflation exceeding its 2% target for two years, the BOJ has hinted at raising short-term rates to a level that neither cools nor overheats the economy, which analysts estimate to be between 1-2%.
Many economists expect the BOJ to raise interest rates to 0.25% this year, although there is disagreement about whether this will happen in July or later. BOJ Governor Kazuo Ueda has stated that the central bank will raise rates if it becomes more confident that inflation will consistently meet the 2% target, supported by strong domestic demand and higher wages. However, recent weak consumption indicators remain a concern. Japan’s economy contracted in the first quarter, partly due to a 0.7% drop in consumption as rising living costs deterred households from increasing spending.
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