Japan's CPI accelerates, timing of interest rate hike remains controversial

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Japan's September inflation data accelerated more than expected, with the core consumer price index (CPI) rising 2.9% year-on-year, remaining above the Bank of Japan's 2% target for more than three consecutive years, adding pressure for a rate hike at next week's policy meeting. Although inflation remains elevated, there are still differences within the central bank regarding the timing of a rate hike, with most analysts expecting the Bank of Japan to keep rates unchanged at this meeting.

Data released by Japan's Ministry of Internal Affairs and Communications on Friday (October 24) showed that after excluding the more volatile fresh food prices, Japan's core CPI in September rose 2.9% year-on-year, higher than August's 2.7% and in line with expectations. This data will be one of the key considerations for the Bank of Japan's two-day policy meeting next week, when the central bank will discuss whether to maintain the 0.5% interest rate and release its latest quarterly growth and price forecasts.

Attention to inflation risk is rising within the Bank of Japan. At the September policy meeting, two out of nine committee members proposed raising rates from the current 0.5% to 0.75%, but the proposal was defeated by majority vote. This is the first time there has been a clear hawkish voice within the central bank.

Newly appointed Prime Minister Sanae Takaichi emphasized that the government should bear ultimate responsibility for economic policy and values close coordination with the central bank. Analysts believe that central bank decision-makers may want more time to consult with the new government and observe more signs of economic strength before taking action.

Acceleration of inflation driven by energy and food

Data shows that the acceleration in September inflation was mainly driven by a rebound in energy costs and continued rises in food prices.

Food prices excluding fresh food rose 7.6% year-on-year. The core indicator excluding both fresh food and fuel costs—which the Bank of Japan sees as better reflecting underlying price trends—rose 3.0% year-on-year in September, down from 3.3% in August.

Service prices rose 1.4% year-on-year in September, far below the 4.2% increase for goods, indicating that companies are only gradually passing on higher labor costs.

Abhijit Surya, senior economist at Capital Economics, said:

"At present, both the inflation rate excluding fresh foods and the rate excluding fresh foods and energy are likely to meet or exceed the Bank of Japan's forecast for this fiscal year."

Concerns over weakening economic growth momentum

Despite continued inflation, economic data shows growth momentum is weakening. The latest Japan Purchasing Managers' Index (PMI) from S&P Global Market Intelligence showed that the momentum of private sector growth further weakened in October.

Annabel Fiddes, associate director of economics at S&P Global Market Intelligence, pointed out that the data indicates that Japan's manufacturing sector remains in contraction, and although the services sector is still a key growth engine of the economy, its weakening momentum is worth watching in the coming months.

Central bank policymakers may want more time to coordinate with the new government and observe more signs of economic strength. Abhijit Surya noted in a report:

The central bank has maintained a cautious tone in recent weeks, with members concerned about the impact of US tariffs on the economy and spillover effects on corporate profits and wage growth.

Uncertainties remain over rate hike path

Last year, the Bank of Japan exited a decade-long aggressive stimulus program and in January raised the short-term interest rate to 0.5%, believing Japan is close to sustainably achieving the 2% inflation target.

Although consumer inflation has exceeded the 2% target for more than three consecutive years, Governor Kazuo Ueda emphasized that given the uncertainty of the impact of US tariffs on Japan's economy, caution is needed with further rate hikes.

Ueda also said that Japan needs to see sustainable inflation driven by strong domestic demand and wage growth before the central bank resumes the rate hike cycle.

Capital Economics believes there is still plenty of reason to resume monetary tightening.

“However, since policymakers still want to gather more information on the economic situation, we expect the next rate hike to take place only in January."

Although most economists and investors expect the central bank to leave rates unchanged next week, persistent inflation above the target and growing internal divisions are causing expectations of a rate hike to continue to rise.

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