1.3%! Japan’s CPI fell for four consecutive months in February, hitting a new low in nearly four years

# Zhao Ying

Source: Wallstreetcn

Japan’s February CPI inflation plunged to **1.3% year-on-year**, the lowest in nearly four years, while core CPI fell below the 2% policy target for the first time in four years. Sustained government fuel subsidies have suppressed inflation, but the Middle East conflict has introduced upward pressure on energy prices, creating a tug-of-war between the two forces. With near-stagnant economic growth and severely distorted inflation signals, the path toward further rate hikes for Bank of Japan Governor Kazuo Ueda is shrouded in uncertainty.

Persistent cooling in Japan’s inflation has complicated the BOJ’s monetary tightening path.

Data released on Tuesday by Japan’s Ministry of Internal Affairs and Communications showed that the consumer price index (CPI) rose **1.3% year-on-year** in February, the lowest level since March 2022. It marked the fourth consecutive month of decline and fell below the Bank of Japan’s 2% policy target.

Meanwhile, core CPI, which excludes fresh food, slowed to **1.6% year-on-year**, below market expectations of 1.7% and also below the 2% target for the first time in nearly four years.

The slowdown in inflation was mainly driven by government fuel subsidies. However, the surge in energy prices triggered by the Middle East conflict poses new upside risks, adding uncertainty to the BOJ’s inflation assessment. The BOJ kept its key interest rate unchanged at **0.75%** last week, while warning about inflation risks stemming from the Middle East situation.

## Core inflation falls below target, making rate timing harder to judge

February core CPI rose **1.6% year-on-year**, down from 2.0% in January. It was the first time since March 2022 that the gauge fell below the BOJ’s 2% target, and also missed economists’ forecast of 1.7%.

Core-core CPI, which excludes fresh food and energy, increased **2.5% year-on-year**, slightly down from 2.6% in January. The BOJ views this measure as a better indicator of demand-driven inflation.

According to Reuters, analysts expect core CPI to remain below 2% in the coming months as the effects of government fuel subsidies persist. Gasoline price controls introduced by the government this month could lower core CPI by as much as **0.5 percentage points**, according to estimates.

BOJ Governor Kazuo Ueda previously stated that the central bank would be ready to raise rates further if it became more confident that underlying inflation would stabilize around the 2% target. Last week, he also said the BOJ would unveil a **new price indicator** before summer to filter out one-off policy effects such as fuel subsidies, allowing a more accurate reading of underlying inflation — a move some analysts see as laying ground for additional rate hikes.

## Government policy and energy shocks distort inflation in opposite directions

Deliberate government intervention has been a major driver behind the inflation cool-down. Prime Minister Sanae Takaichi pledged during her campaign to suspend the 8% food tax for two years, and the government has rolled out multiple measures to ease cost-of-living pressures, including fuel subsidies. While these actions have depressed headline inflation, they have also made it harder for the BOJ to assess underlying price pressures accurately.

The BOJ had previously forecast that annual consumer inflation could fall below 2% in the first half of this year due to such policies. It projects core CPI and core-core CPI at **1.9%** and **2.2%** respectively for fiscal 2026 (starting April 1).

At the same time, energy price shocks from the Middle East conflict are exerting upward pressure. Speaking to CNBC, Stefan Angrick, Senior Economist for Japan and Frontier Markets at Moody’s Analytics, called the conflict a “disturbing surprise.” A surge in commodity prices could create a supply shock and push inflation higher, “which is bad news for a net importer of energy and food like Japan.” He noted that the economic impact would likely be limited if the conflict ended relatively quickly, but could become severe if it dragged on.

## Weak growth complicates policy trade-offs

Slowing inflation combined with fragile economic growth is further constraining the BOJ’s policy room. Japan’s economy expanded just **0.1% year-on-year** in the fourth quarter of last year, a sharp slowdown from 0.6% in the third quarter, narrowly avoiding a technical recession.

The BOJ ended its decade-long ultra-loose monetary policy in 2024 and raised rates multiple times, including in December last year, citing steady progress toward sustainably achieving the 2% inflation goal. However, the ongoing decline in inflation readings has made markets more cautious about the timing of the next rate increase.

Persistent government price interventions have distorted inflation figures, presenting the BOJ with greater challenges in gauging underlying price trends. Ueda’s plan to introduce a new price indicator is interpreted by some analysts as an attempt to find clearer justification for tightening amid policy noise.

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