Tokyo's Core Inflation Surges, Fuels Rate Hike Speculation

Tokyo's core inflation has accelerated for the fourth consecutive month, tracking above the Bank of Japan's (BOJ) 2% target.
This trend is largely attributed to the phase-out of government subsidies on utility bills and rising rice prices.
The BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25% in July.
The BOJ is ready to raise interest rates further if inflation remains on track to hit its 2% target, indicating a shift in monetary policy.

Tokyo, Japan's capital, has recently witnessed a steady acceleration in core inflation for the fourth consecutive month in August. The data, released on Friday, indicates that the inflation rate is comfortably tracking above the Bank of Japan's (BOJ) 2% target.

This development reinforces market expectations of further interest rate hikes in the future. The Tokyo core consumer price index (CPI), which excludes the volatile fresh food costs, rose by 2.4% in August from a year earlier. This increase is faster than the median market forecast of 2.2% and the 2.2% gain recorded in July.

Inflation Trends and Contributing Factors

A separate index, which strips away the effects of both fresh food and fuel costs, rose by 1.6% in August from a year earlier, following a 1.5% rise in July. This index is closely watched by the BOJ as a broader price trend indicator. The accelerated inflation in Tokyo, considered a leading indicator of nationwide trends, is largely attributed to the phase-out of government subsidies on utility bills and rising rice prices due to intensifying shortages caused by extreme heat. Takeshi Minami, chief economist at Norinchukin Research Institute, noted, Some one-time factors pushed up inflation but the underlying inflation trend will continue to moderate in coming months.

However, with wage growth expected to drive private consumption and push up inflation, the case is growing for the Bank of Japan to raise interest rates further, according to Minami. This perspective aligns with the BOJ's outlook, which expects rising wages to push up service prices and keep inflation durably around 2%.

BOJ's Monetary Policy Shift

In a landmark move away from a decade-long radical stimulus program, the BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25% in July. BOJ Governor Kazuo Ueda stated that the central bank would raise rates further if inflation remains on track to durably hit its 2% target in the coming years, as projected by the BOJ board.

In related news, the Ministry of Economy, Trade and Industry upgraded its assessment on industrial output for the first time since March last year. Data showed that output rose by 2.8% in July from the previous month. Manufacturers surveyed by the ministry expect output to increase by 2.2% in August and contract by 3.3% in September. However, an official cautioned vigilance over the outlook, adding that production plans might not be as strong as expected in August.

Global Factors and Market Expectations

The BOJ's recent monetary policy changes and the hawkish signal from Governor Ueda triggered a market rout, forcing his deputy to offer dovish reassurances that no hikes would come until markets stabilize. Ueda reaffirmed his resolve to raise interest rates if inflation stayed on course to sustainably hit the 2% target, but warned that financial markets remained unstable.

The market volatility seen in early August was due to rising fears of a US recession, stoked by the country's weak economic data, while the BOJ's interest rate hike in July led to a sharp reversal of one-sided yen falls. Ueda stated, Markets at home and abroad remain unstable, so we will be highly vigilant to market developments for the time being.

The central bank's readiness to raise interest rates further if inflation remains on track to hit its 2% target suggests a cautious but proactive approach to managing the country's economic growth and inflation. However, the BOJ's decisions and the market's expectations are influenced by global factors, such as the US GDP data and its implications for the US Federal Reserve's monetary policy, as well as global market instability.