Underlying inflation pressure rises in Japan

Underlying inflation pressure in Japan raced ahead in March. The so‑called core‑core inflation (inflation excluding fresh food and energy prices) rose by 3.8% year on year, accelerating from the 3.4% increase in February, according to data from the Ministry of Internal Affairs and Communications on April 21st. This came despite a slower headline inflation rate of 3.2% (down from 3.3% in February) and stable core inflation (inflation excluding fresh food), which rose by 3.1%, unchanged from February.

The data indicate that inflation in Japan is increasingly driven by a domestic factor (inflation expectation), leading businesses to raise prices. This occurred just before the first meeting by the Bank of Japan (BOJ, the central bank) under the new governor, Ueda Kazuo, who has been tasked with normalising the ultra‑accommodating monetary policy. The data provide evidence that inflation expectation has risen—a change from the long-held deflationary mindset of the previous decades.

The change could have been brought about by a few factors. Domestically, the government under the prime minister, Kishida Fumio, has been pushing for higher wage growth in the private sector. At the latest annual wage negotiation meeting in spring (shunto), companies agreed to raise wages by 3.8% on average, up from the average rise of 2.2% in 2022. This pushed up prices even in the service sector, which is typically among the most subdued, by 1.5% in March.

Although energy prices fell by 3.8%, it was partially owing to government subsidies. The prospect of a prolonged war in Ukraine led businesses and households to expect commodity prices to remain elevated for an extended period of time; fresh food prices continued to rise by 5.4% year on year in March. These factors have motivated businesses in Japan to raise prices. The latest Tankan survey by the BOJ showed that Japanese companies expect inflation to remain elevated at 2.8% at the end of fiscal year 2023/24 (end‑March 2024), exceeding the BOJ’s target of 2%.

The March inflation data will feed into the market expectation of a “tapering” move by the BOJ. Although the central bank may not necessarily change its monetary policy setting at the first meeting on April 27th‑28th, the latest inflation data will motivate the BOJ to look for ways to guide inflation expectations back to the 2% target. We expect the underlying inflation pressures to persist in the coming months, which will give the central bank the justification to begin normalising policy in 2023.We believe that the BOJ will start by loosening yield-curve control further before ending it by the end of the year.