Japan’s inflation accelerates, supporting Bank of Japan rate hike

(Bloomberg) — Japan’s inflation is accelerating on the back of rising energy costs, giving the central bank reason to consider raising interest rates in coming months.

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The Ministry of Internal Affairs and Communications said on Friday that consumer prices excluding fresh food rose 2.5% year-on-year in May, accelerating from 2.2% in April. The figure was slightly below economists’ expectations but exceeded the Bank of Japan’s 2% target for the 26th consecutive month. Inflation was driven by a 14.7% increase in electricity prices.

The national results were broadly in line with Tokyo’s May figures released three weeks ago.

The key indicator accelerated again after two months of slowing, providing a basis for the Bank of Japan to consider raising interest rates as soon as next month, when it is expected to announce details of its plans to reduce bond purchases.However, it is questionable whether Friday’s report will be strong enough to prompt a rate hike, said Atago Nobuyasu, chief economist at Rakuten Securities Economic Research Institute.

“The recovery of the consumer price index is within the range of expectations, and I don’t think this report alone will be a deciding factor for the BOJ’s next interest rate hike,” Atago said. “I don’t think the BOJ can say that this report alone has increased the certainty of achieving the 2 percent inflation target.”

Atago said the BOJ may have to wait to raise interest rates until it sees second-quarter economic growth data due in August.

Bloomberg Economics’ take…

“The rise was mainly due to cost-pushers and not rising demand. There was little evidence that faster wage growth, a scenario the BOJ has been hoping for, would boost services inflation. Still, the core index’s further increase above its 2% inflation target is consistent with the central bank’s price outlook.”

— Taro Kimura, economist

For the full report, click here.

For now, Governor Kazuo Ueda is keeping his options open. Asked last week whether authorities might raise rates at the same meeting, Ueda replied “of course.” He further underscored the possibility of an earlier rate hike by telling parliament on Tuesday that a rate hike was likely as soon as next month, depending on economic and financial conditions.

Still, there is reason for caution. A deeper measure of inflation that excludes fresh food and energy prices rose 2.1% in May, its ninth consecutive month of declines. And service price increases, which the Bank of Japan has highlighted as a key driver of its policy deliberations, eased to 1.6% after slowing sharply to 1.7% in April. The slowdown may suggest that companies are becoming increasingly reluctant to raise prices further as rising costs increasingly discourage consumers from buying more.

“Services inflation is weak and is negative for monetary policy. Ideally, wage increases would be passed on to prices, leading to a stable rise in prices,” said Atsushi Takeda, chief economist at the Itochu Economic Research Institute.

Among the items dragging the index down were processed foods, whose price increases slowed to 3.2% due in part to base effects. The number of food items whose prices rose in May was less than half what it was in the same month last year, according to the latest survey by Teikoku Databank.

There are both upward and downward factors that will affect prices going forward. One of the main factors driving prices higher is the weakening of the Japanese yen. For much of the past month, the yen has been trading within a few yen of its 34-year low against the dollar.

The yen was trading around 158.85 to the dollar in Tokyo on Friday morning, triggering a flurry of verbal intervention. Masato Kanda, head of foreign exchange, said there was no change to the bank’s stance of taking appropriate measures if the currency fluctuated excessively.

The interest rate differential between Japan and other countries remains large, which is expected to continue to pressure the yen against various currencies and further accelerate price increases due to imports.Trade data for May showed Japan’s trade deficit widened to more than 1 trillion yen ($6.3 billion) as the weak yen boosted imports.

Ueda said authorities needed to monitor how the yen and import prices were affecting the overall economy.

Another upside risk comes from energy policy. The government began phasing out utility subsidies in May, temporarily cutting consumers’ electricity and gas bills by as much as 20%. Economists expect inflation to approach 3% over the summer as a result of the removal of utility subsidies and higher renewable energy levies.

Meanwhile, sluggish consumption is cooling inflation. Japanese consumer sentiment fell to its steepest in two years in May as households grew worried about prolonged inflation.

For Prime Minister Fumio Kishida, who is trying to pull Japan out of deflation, one of the key issues is whether he can create a virtuous cycle that links wages with demand-driven price increases. With wage increases taking effect in June and the government’s income tax refunds, consumers’ disposable income is expected to increase. It remains to be seen to what extent the increased income will stimulate consumption and prices.

The prime minister is pinning his final hopes on an economic upturn as his chances of leading his long-ruling Liberal Democratic Party to another election look fading, with two opinion polls over the weekend showing his approval rating among voters falling to its lowest since he took office in 2021.

–With cooperation from Yoshiaki Nohara and Keiko Ujikane.

(Updates with economist comment and details)

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