Japan's Tokyo CPI cooled down again in March, hitting the lowest growth rate in four years, but the Bank of Japan still expects to raise interest rates in April

# By Bao Yilong

Source: Wall Street CN

Tokyo’s overall CPI rose 1.4% year-on-year in March, the slowest pace since March 2022. Core CPI, which excludes fresh food, increased 1.7%, below the forecast 1.8% and further below the Bank of Japan’s 2% annual target. Despite the soft readings, analysts warn of significant upside risks to inflation ahead, leaving the door open for a 25-basis-point rate hike in April.

Tokyo inflation cooled unexpectedly again, dampening market expectations for an imminent BoJ rate hike and pushing the yen weaker toward the 160 level against the dollar.

Data released by Japan’s statistics bureau on Tuesday showed Tokyo’s headline CPI climbed 1.4% from a year earlier in March, the weakest growth since March 2022. Core CPI excluding fresh food rose 1.7%, missing the 1.8% consensus estimate and falling further below the BoJ’s 2% inflation goal.

The weaker-than-expected inflation figures, combined with uncertainty over the economic outlook stemming from Middle East tensions, have significantly reduced market bets on an immediate BoJ rate hike. Following the data release, USD/JPY found buying support and neared the 160 mark during the session.

However, Taro Kimura, economist at Bloomberg Economics, noted that the BoJ is on guard against oil price-driven inflation that could lift longer-term inflation expectations. A 25-bp rate increase in April remains on the table, as previous policy normalization has not noticeably weighed on growth.

## Broad-based inflation cool-down; core gauge hits 13-month low

Tokyo’s March inflation data showed a broad-based decline.

Headline CPI eased to 1.4% from a revised 1.5% in February. Core-core CPI, which excludes fresh food and energy, slowed to 2.3% from 2.5%, marking a 13-month low and serving as a key benchmark for the BoJ to gauge underlying inflation.

The slowdown largely reflected narrower gains in processed food prices, which rose 4.9% in March after a 5.5% increase the previous month.

On the energy front, overall energy prices fell 7.5% year-on-year, a slightly smaller drop than the 9.2% decline in February. Gasoline prices narrowed their decline sharply to 1.0% from 14.7% in February. Japanese statistics are collected around mid-March, when the Middle East conflict had only just begun to push oil prices higher.

Services prices held steady at a 1.5% year-on-year increase, while rice price gains cooled drastically to 8.3% from 18.2% in February.

Japan’s persistent inflation moderation has also been closely linked to the Kishida government’s policies to cap utility and food prices. Analysts expect the government to maintain related subsidies in the near term amid energy price shocks from the Middle East.

## Middle East tensions pose upside inflation risks

Despite the current soft readings, multiple warnings highlight significant upside risks to the inflation trajectory ahead.

Kohei Okazaki, chief market economist at Nomura Securities, stated:

“The impact of Middle East tensions will gradually emerge. If international oil prices remain at current levels, headline inflation will likely rise to a range of 2.5% to 3% in the second half of the year.”

He added:

“If the yen weakens further, inflation could even exceed 3% in the latter half of the year.”

The BoJ has previously signaled a temporary inflation slowdown, projecting a rebound later in the year as government subsidy effects fade and wages rise further. The central bank has clearly outlined its rate hike path in policy statements, with its next meeting scheduled for April 28.

A separate report by Teikoku Databank on Tuesday showed food and beverage companies will raise prices on nearly 2,800 products in April, the largest wave of price hikes since last October.

Another report from the firm showed more than 1,500 Japanese companies operate in the Middle East, facing direct risks from supply chain disruptions and rising raw material costs across imports such as marble, fish feed, and lubricants.

## Other data point to weak domestic demand

Additional economic data released on Tuesday underscored pressure on Japan’s domestic demand.

Japan’s industrial output fell 2.1% month-on-month in February, slightly worse than the expected 2.0% decline, and rose just 0.3% year-on-year. Manufacturers forecast a 3.8% month-on-month rebound in March and a further 3.3% increase in April. However, Kohei Okazaki noted:

“These projections were surveyed as of March 10, before the full impact of Middle East tensions had been factored in.”

Consumer spending remained soft as well. Retail sales dropped 2.0% month-on-month and 0.2% year-on-year in February.

The labor market, by contrast, remained resilient. Data from Japan’s Ministry of Health, Labour and Welfare showed the unemployment rate edged down to 2.6% in February, while the jobs-to-applicants ratio rose slightly to 1.19, meaning 119 positions were available for every 100 job seekers.

A persistently tight labor market supports wage growth, a key pillar underpinning market expectations for the BoJ to stay on its rate hike path.

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