Core inflation in Japan’s capital surged to a more than two-year high in May, primarily driven by persistent increases in food costs, according to data released on Friday.
This development intensifies the pressure on the Bank of Japan (BOJ) to consider further interest rate hikes, even as separate figures revealed a concerning slide in factory output, highlighting the central bank’s complex balancing act.
The Tokyo core consumer price index (CPI), a key metric that excludes volatile fresh food costs, rose by 3.6% in May compared to a year earlier.
This figure surpassed market forecasts, which had anticipated a 3.5% gain, and marked an acceleration from the 3.4% rise recorded in April.
The May reading represents the fastest annual pace of increase since January 2023, when core inflation hit 4.3%.
Significantly, core inflation in Tokyo, widely regarded as a leading indicator of nationwide price trends, has now exceeded the Bank of Japan’s 2% target for three consecutive years.
Further underscoring the broadening price pressures, a separate index that strips away the effects of both fresh food and fuel costs—a measure closely watched by the BOJ as an indicator of underlying price trends—rose by 3.3% in May from a year earlier, up from a 3.1% rise in March.
This persistent upward creep in prices is leading some analysts to recalibrate their expectations for BOJ policy.
“The Tokyo CPI showed a further broad-based acceleration in inflation, which suggests that the BOJ may hike even earlier than our current forecast of October,” commented Marcel Thieliant, head of Asia-Pacific at Capital Economics.
A Reuters poll conducted between May 7-13 indicated that most economists expect the BOJ to hold rates steady through September, with a small majority forecasting a rate hike by the end of the year.
Food costs and services drive inflation; factory output falters
Sticky food inflation remained the primary driver of the overall rise, with non-fresh food prices climbing 6.9% in May year-on-year, and the cost of rice experiencing a staggering 93.2% surge.
However, services inflation also gathered pace, accelerating to 2.2% in May from 2.0% in April. This suggests that companies are gradually beginning to pass on rising labor costs to consumers.
“The fact services prices rose is positive for the BOJ, which wants to keep alive expectations of further rate hikes,” observed Masato Koike, senior economist at Sompo Institute Plus.
However, he also pointed to external uncertainties: “But US policy uncertainty will make it hard to keep the BOJ from hiking too soon. By the time the dust settles, price developments could have changed in a way that makes rate hikes difficult.”
The inflationary concerns are juxtaposed with signs of weakness in the manufacturing sector.
Separate data released on Friday showed that Japan’s factory output fell by 0.9% in April compared to the previous month.
While manufacturers surveyed by the government expect output to increase by 9.0% in May, they anticipate a subsequent drop of 3.4% in June.
This indicates that manufacturers are feeling the pinch from slowing global demand and the economic repercussions of steep US tariffs, which could hurt their profits and discourage them from raising wages next year.
Many analysts also expect overall consumer inflation to slow in the coming months due to falling crude oil prices and a drop in import costs resulting from the yen’s recent rebound.
The BOJ’s tightrope walk: inflation vs. growth headwinds
Despite potential moderating factors, persistent food inflation may not allow the Bank of Japan to pause its rate hike considerations for an extended period.
A survey by private think tank Teikoku Databank, released on Friday, revealed that Japanese firms plan to hike prices for 1,932 food and beverage items in June, a figure triple that of a year ago.
This signals that more price increases are on the horizon for consumers.
BOJ Governor Kazuo Ueda acknowledged these dynamics in a parliamentary address on Friday, stating that the central bank was “mindful that companies continued to actively hike wages and raise prices to pass on higher costs.”
Adding to this, Tsutomu Watanabe, an academic at the University of Tokyo’s graduate school of economics, warned, “Japan may face a tricky situation where public attention to rising food prices heighten inflation expectations, which have so far been stable.”
The Bank of Japan ended its massive stimulus program last year and, in January, raised short-term interest rates to 0.5%, predicated on the view that Japan was on the verge of durably achieving its 2% inflation target.
While the central bank has signaled its readiness to raise rates further, the economic fallout from higher US tariffs has forced it to cut its growth forecasts, thereby complicating decisions around the timing of the next rate increase.
The BOJ now faces the delicate task of taming inflation without derailing a fragile economic recovery.
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