Japan’s Core Inflation Rises in July, But Slowing Demand Growth May Complicate BOJ’s Rate Decisions

Japan’s core inflation rate accelerated for the third consecutive month in July, according to data released on Friday, raising challenges for the Bank of Japan (BOJ) as it considers future interest rate hikes. The nationwide core Consumer Price Index (CPI), which excludes volatile fresh food items, rose 2.7% year-on-year, slightly up from a 2.6% increase in June. This figure aligns with the median market forecast and marks the 28th consecutive month that inflation has been at or above the BOJ’s 2% target.

However, the “core core” index, which excludes both fresh food and energy costs and is closely monitored by the BOJ as a key indicator of underlying inflation trends, showed a slowdown. It increased by 1.9% in July, down from 2.2% in June, dipping below the critical 2% threshold for the first time since September 2022.

Masato Koike, a senior economist at Sompo Institute Plus, noted that the rise in core CPI was largely driven by the phase-out of government subsidies aimed at reducing household utility bills. Without this factor, overall inflation appears to be decelerating. The reinstatement of utility bill relief and the recent appreciation of the yen, which lowers import costs, are expected to further slow core CPI growth in the coming months.

This slowdown in demand-driven price growth complicates the BOJ’s decision-making process regarding further interest rate hikes. In July, the BOJ surprised markets by raising interest rates to a 15-year high and signaled its willingness to continue increasing borrowing costs if inflation appears likely to consistently meet its 2% target. However, the recent inflation data could temper the central bank’s approach, as it may indicate that inflationary pressures are easing rather than becoming entrenched.