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Japan’s core inflation accelerated in June but remained below the Bank of Japan’s 2 per cent target for a fifth consecutive month, even as a weaker yen and rising producer prices threaten to create fresh inflationary pressure in the economy.
The core consumer price index (CPI), which excludes volatile fresh food prices, rose 1.6 per cent in June from a year earlier, government data showed on Friday. The increase followed a 1.4 per cent rise in May and matched the median market forecast.
The data suggest that Japanese companies have yet to fully pass higher input costs on to households. But economists expect consumer inflation to accelerate later this year as rising fuel and import costs feed through the economy.
The yen’s slide to a four-decade low against the US dollar is adding to those concerns. A weaker currency raises the cost of imported energy, raw materials and other goods, potentially putting further pressure on Japanese companies and consumers.
That could strengthen expectations of further interest rate hikes by the Bank of Japan.
“The inflation outlook will largely depend on developments in the Middle East and their impact on global commodity prices,” said Sarah Tan, an economist at Moody’s Analytics.
“The concern is that nominal wage growth may not keep pace with inflation, which will weigh on real wages and dampen consumer spending. A renewed depreciation of the yen would further intensify imported inflation.”
Why Japan’s inflation outlook is changing
The rise in June’s core inflation was partly driven by a base effect. Gasoline prices had fallen sharply a year earlier after government subsidies, making the year-on-year comparison less favourable.
Food inflation moderated as rice prices declined. Services inflation also slowed to 1.2 per cent from 1.4 per cent in May, despite continued wage gains.
An index that excludes both fresh food and energy prices, which is closely watched as a gauge of underlying inflation, rose 1.7 per cent year-on-year in June. That was slightly lower than the 1.8 per cent increase recorded in May.
The relatively moderate consumer inflation figures suggest that rising costs have not yet fully translated into higher prices for households.
However, producer prices are sending a different signal.
Japan’s producer price index surged 7.1 per cent in June from a year earlier, marking the fastest increase in more than three years. The sharp acceleration points to rising cost pressures for businesses and increases the risk that companies will eventually pass those costs on to consumers.
The pressure has been intensified by higher energy and import costs linked to the conflict in West Asia and the weak yen.
“There are no clear signs in the consumer price data that the BOJ’s concerns about upside risks to inflation are materialising,” said Marcel Thieliant, head of Asia-Pacific at Capital Economics.
“Producer price inflation has accelerated sharply in recent months. With crude oil prices approaching their recent peaks and the yen falling to fresh lows against the dollar, the Bank’s concerns about upside risks to inflation won’t have dissipated.”
Why the weak yen matters for the BOJ
Japan is heavily dependent on imported energy and raw materials. A weaker yen makes those imports more expensive in domestic currency terms.
That creates a difficult policy challenge for the BOJ.
If companies absorb higher costs, their profit margins could come under pressure. If they pass those costs on to consumers, inflation could accelerate. At the same time, households could see their purchasing power weaken if wages fail to keep pace with rising prices.
The risk is particularly important for the BOJ because it is trying to determine whether inflation is becoming a sustained feature of the Japanese economy or is merely being driven by temporary external shocks.
The central bank is also closely watching the relationship between wages and prices. Strong wage growth could help support consumption and create a more durable inflation cycle. But if prices rise faster than incomes, households could cut spending, weakening economic growth.
“The concern is that nominal wage growth may not keep pace with inflation,” Tan said.
That could leave Japan facing imported inflation without the stronger domestic demand that would normally support a sustainable economic recovery.
BOJ faces rate-hike dilemma
The inflation data will be among the factors the BOJ examines at its policy meeting next week. The central bank is widely expected to keep interest rates unchanged and issue fresh quarterly economic and inflation projections.
The BOJ has been gradually moving away from its long-standing ultra-loose monetary policy as inflation and wage growth have become more persistent.
But a weak yen and higher energy prices could complicate that process.
A rate hike could help support the yen by making Japanese assets more attractive and reducing the gap between Japanese and overseas interest rates. That could help contain imported inflation.
However, higher borrowing costs could also weigh on businesses and households at a time when the economy is already facing higher energy and import costs.
The central bank therefore faces a delicate balancing act: allowing inflation to remain sufficiently strong to break Japan’s long-running deflationary cycle, while preventing imported price pressures from eroding household incomes and consumer spending.
Japan firms passing on costs faster
An annual government white paper released on Friday said Japanese companies are passing on rising costs linked to the West Asia conflict at a faster pace than they did in 2022, when the war in Ukraine pushed up fuel prices.
Corporate and household inflation expectations are also accelerating, the report said.
That development supports the BOJ’s view that inflationary pressures may be becoming more embedded in an economy that spent decades struggling with deflation.
The white paper also pointed to continued corporate investment. Companies’ spending plans have remained above their historical average for two consecutive years, suggesting that businesses have so far shown resilience despite the energy shock.
However, the government warned that close attention was needed to assess the impact of the West Asia conflict on Japan’s economy and its output gap.
For the BOJ, the central question is whether rising producer prices and a weak yen will eventually translate into sustained consumer inflation.
If they do, the central bank could face growing pressure to raise interest rates again — even as higher prices threaten to squeeze household purchasing power and slow consumer spending.
