A few hours before the Bank of Japan announced its interest rate decision, the latest data showed that Japan's main inflation indicator reached 3% for the first time in 16 months, highlighting the continued upward trend of Japanese prices.
Data released by the Ministry of Internal Affairs and Communications on Friday showed that Japan's national core CPI rose 3% year-on-year in December due to rising energy prices, higher than the previous value of 2.7%. This data is in line with market expectations and is the first time that the indicator has reached 3% since August 2023.
This acceleration is consistent with the trend of Tokyo's CPI in December released at the end of last year. Data showed that Tokyo's core CPI in December, excluding fresh food, rose 2.4% year-on-year, higher than the previous value of 2.2%, the highest level since August last year. Rising energy prices are the main driving force behind Tokyo's higher inflation after the gradual elimination of gas and electricity subsidies. Across Japan, energy prices in Japan rose 10.1% in December.
In addition, Japan's service sector inflation also accelerated slightly to 1.6% in December, while the national core-core CPI, which excludes energy costs and fresh food prices, rose 2.4% year-on-year in December, the same as the previous value.
The solid inflation data supports the case for the Bank of Japan to raise interest rates on Friday. Markets and economists generally expect the Bank of Japan to announce a rate hike in a few hours. Such expectations have been heating up recently, especially after the top officials of the Bank of Japan pointed out positive progress in wage increases and the market remained relatively calm in the first few days after Trump took office.
"The data has given the Bank of Japan solid confidence," said Atsushi Takeda, chief economist at Itochu Research Institute. "The central bank can confirm that there is no need to postpone the rate hike."
The latest survey showed that about three-quarters of economists surveyed expected the Bank of Japan to raise interest rates on Friday. And overnight index swaps showed that the Bank of Japan's rate hike in January has been fully priced in by the market.
The Bank of Japan will also release its quarterly economic outlook report after the policy meeting on Friday. It is reported that Bank of Japan officials will raise their basic inflation expectations for this fiscal year and the next fiscal year. The Bank of Japan in October forecast inflation, excluding fresh food and energy, would rise 2 percent in the fiscal year to March and 1.9 percent next year.
“The pick-up in Japan’s December inflation data will allow the Bank of Japan to finally agree to a widely expected rate hike today,” said Taro Kimura, an economist at Bloomberg Economics.
The yen is likely to remain under pressure despite the Bank of Japan’s expected rate cut on Friday, with higher import costs supporting inflation in a weaker currency. The dollar has been trading around 155 yen per dollar or higher for about a month, reflecting expectations that interest rates between the U.S. and Japan will remain far apart for some time.
Meanwhile, rising prices continue to weigh on consumers amid sluggish wage growth, posing a major challenge for Prime Minister Shigeru Ishiba. The Bank of Japan’s latest quarterly household sentiment report showed Japanese households’ inflation expectations rose to their highest level on record as the cost of living remains high.
To mitigate the impact, the Ishiba government has unveiled an economic plan that includes utility subsidies to be restored from January to March, as well as cash handouts to low-income households. The restoration of subsidies could lead to lower inflation again.
Japan's parliament will resume later on Friday. The Ishiba government is likely to face a key test of whether it can pass this year's initial budget in time. The slew of measures the Ishiba government is expected to introduce are expected to support future wage growth, a key component of the virtuous economic cycle long sought by the government and the Bank of Japan.