Japan's core inflation rises, but demand-driven growth remains below 2 percent

Core consumer price inflation in Japan rose for the third straight month in July, data showed on Friday, but further interest rate hikes by the central bank could be complicated by a slowdown in demand-led price growth in the coming months.

The nationwide consumer price index (CPI), which excludes fresh food, rose 2.7 percent year-on-year, up from 2.6 percent in June, in line with the median market forecast and keeping the inflation rate at or above the central bank's 2 percent target for the 28th consecutive month.

However, the “core core” index, which excludes both fresh food and energy costs and is seen by the BOJ as the closest proxy for its key gauge of overall inflation trends, rose 1.9 percent, compared with a 2.2 percent rise in June, falling below the key 2 percent mark for the first time since September 2022.

“The rise in the core CPI reflects a gradual reduction in government subsidies to reduce household electricity bills. If this factor is ignored, overall inflation is slowing,” said Masato Koike, senior economist at the Sompo Institute Plus.

Relief in utility costs has been restored and import costs are currently being reduced by the recent recovery of the yen, so core consumer price index growth “is likely to slow down in the subsequent period,” he said.

These inflation data will be key to the BOJ's decisions on further rate hikes in the future. Last July, it surprised markets by raising interest rates to a 15-year high and signaled its willingness to raise borrowing costs further as prospects grow that inflation could reach its 2 percent target on a sustained basis.

It was the BOJ's aggressive tone that pushed up the battered yen and sent Tokyo stocks plunging to their biggest one-day low since the Black Monday sell-off in 1987. Markets have since stabilized.

BoJ Governor Kazuo Ueda was summoned on Friday to explain the BoJ's July decision to raise interest rates. He reiterated his determination to raise rates again if inflation remains on track and sustainably reaches the 2 percent target.

He also mentioned that, given the ongoing instability in financial markets, the central bank will “continue to monitor market developments with the utmost vigilance for the time being.”

Despite the muted reaction of currency markets to the inflation data, repeated statements of Ueda's willingness to consider possible future interest rate hikes pushed the yen higher. On Friday afternoon, the yen was trading at around 145.50 per dollar after fluctuating on some other comments.

Data last week showed that Japan's economy recovered much faster than expected in the second quarter on the back of solid consumption, bolstering the case for the central bank to maintain its monetary tightening stance.