Japan's Inflation Hits 3%, Supporting Case for BOJ Rate Hike
Japan's key inflation gauge surged to 3% in December, marking the first time it reached this level in over a year. This acceleration underscores the nation's ongoing price momentum and supports expectations of a third rate hike by the Bank of Japan (BOJ) under Governor Kazuo Ueda.
Excluding fresh food, consumer prices rose by 3% year-over-year in December, driven by higher energy costs. This increase surpasses the previous month's rate of 2.7%, matching consensus estimates. It also marks the first time inflation has hit 3% since August 2023.
Rising energy prices, particularly after the discontinuation of gas and electricity subsidies, have significantly contributed to inflation in both Tokyo and the nation as a whole. Nationally, energy prices soared by 10.1% in December. Service inflation also saw a slight increase to 1.6%, while an index excluding energy and fresh food prices advanced by 2.4%, remaining unchanged from November.
The robust inflation data strengthens the case for the BOJ to raise interest rates later today, a move widely anticipated by markets and economists. Speculation of a January rate hike has intensified following positive developments in wage hikes highlighted by the BOJ's top officials. Markets have remained relatively calm during the initial days of President Donald Trump's second term.
"The data provide solid reassurance for the BOJ," said Atsushi Takeda, chief economist at Itochu Research Institute. "The bank can confirm that there is no need to hesitate in raising rates."
According to a recent Bloomberg poll, approximately 75% of economists predict a rate increase today, while overnight-indexed swaps indicate that the market is almost fully expecting a January rate hike.
In addition to the rate decision, the BOJ is also expected to release its quarterly economic outlook report, where officials may upgrade their inflation forecasts for the current and upcoming fiscal years. In October, the bank projected inflation excluding fresh food and energy to rise by 2% and 1.9% in the current and subsequent years, respectively.
Despite the anticipated rate hike, Japan's currency may continue to face downward pressure, contributing to higher import costs and supporting inflation. The yen has traded below 155 against the dollar for approximately a month, reflecting expectations of a significant interest rate differential with the United States in the near future.
Elevated prices continue to impact consumers, given the lackluster wage growth, posing a major challenge for Prime Minister Shigeru Ishiba. The BOJ's latest quarterly household sentiment report indicates that Japan's household inflation expectations have reached a record high amid the persistent increase in living costs.
To address the impact, Ishiba's government has introduced an economic package that includes utility subsidies to be reinstated from January to March, as well as cash handouts for low-income households. These subsidies are likely to lead to a temporary decline in inflation.
The regular diet session will resume later today, where Ishiba will face scrutiny over the timely passage of the initial budget for this year, as opposition parties seek influence. Earlier, Ishiba's minority ruling coalition elected to increase the tax-free income ceiling to ¥1.23 million ($7,880.6) from the previous ¥1.03 million, partly aimed at boosting disposable income and stimulating private consumption. This proposal originated from the opposition Democratic Party for the People, whose support was crucial for the passage of the economic package.
Ishiba's measures also provide support for future wage growth, a critical element in the virtuous economic cycle desired by both the government and the BOJ. Japan's largest union federation has demanded an overall wage increase of at least 5%, matching last year's demand.
"The data suggest a gradual but steady movement towards the price stability target," said Itochu's Takeda. "There is progress in the virtuous cycle between wages and prices."