Japan inflation accelerates in July, strengthening case for BOJ rate hike

Japan’s core consumer inflation rose faster in July, adding to expectations that the Bank of Japan (BOJ) could raise interest rates again at its September meeting.

Core consumer prices, which exclude volatile fresh food prices, rose 1.8 per cent in July from a year earlier, government data showed on Friday. Inflation had risen 1.6 per cent in June. The July figure was in line with economists’ expectations.

The data will be closely watched by the BOJ as it considers its next policy move on September 17 and 18. The central bank is widely expected to raise its policy rate to 1.25 per cent from 1 per cent.

Inflation remains below BOJ target

Despite the increase, core inflation remained below the BOJ’s 2 per cent target for a seventh consecutive month.

Government measures to reduce fuel costs have helped keep inflation lower. But economists expect price pressures to increase in the coming months as companies pass higher costs for raw materials and imports on to consumers.

An inflation measure that excludes both fresh food and energy prices rose 1.9 per cent in July, up from 1.7 per cent in June. The BOJ closely watches this measure because it gives a clearer picture of underlying price pressures.

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Services prices also increased faster. Service-sector inflation rose 1.2 per cent in July, compared with 1.1 per cent in June.

This suggests companies are beginning to pass higher labour costs on to consumers as Japan continues to face a tight job market.

Weak yen adds to price pressure

A weaker yen is another concern for Japan.

Japan imports much of the energy and raw materials used by its companies. When the yen weakens, these imports become more expensive in local currency terms.

Companies can absorb some of these costs. But when they pass them on to consumers, prices rise.

Renewed tensions in West Asia could add to these pressures by pushing up crude oil prices.

“Core consumer inflation is likely to re-accelerate given renewed tension in the Middle East, which will push up crude oil prices and add to price pressures from a weak yen,” Masato Koike, senior economist at Sompo Institute Plus, told Reuters.

He expects the BOJ to raise interest rates in September.

Why a September rate hike matters

The BOJ raised its policy rate to 1 per cent in June, taking it to the highest level in 31 years.

The central bank left rates unchanged at its July meeting but warned that inflation risks were increasing.

The latest data could strengthen the argument for another rate increase.

Reuters reported earlier this month that BOJ policymakers were considering a rate hike as soon as September. The central bank is also considering whether it needs to raise rates more frequently than its current pace of roughly twice a year.

However, the BOJ faces a difficult balancing act.

Higher interest rates can help control inflation, but they also increase borrowing costs for households and businesses. A sharp increase in rates could weaken consumer spending and investment.

Japan’s economy grew at an annualised 1.1 per cent in the April-June quarter, slower than economists had expected. Private consumption also fell slightly during the quarter.

That means the BOJ will have to weigh persistent price pressures against the risk of hurting economic growth.

What happens next?

The July inflation figures give the BOJ another reason to consider raising rates in September.

The key question is whether inflation continues to move towards the central bank’s 2 per cent target without causing a sharp slowdown in the economy.

If companies continue to pass higher import, energy and labour costs on to consumers, inflation could rise further in the months ahead.

That would make a September rate hike more likely and could signal the beginning of a faster tightening cycle for Japan’s central bank.