The rise in inflation compounded the yen falling below 164, and the Bank of Japan's interest rate hike was “in the arrow”

The Zhitong Finance App learned that Japan's core inflation index rebounded for the first time in three months in June, providing support for the Bank of Japan to raise interest rates further during the year. According to data released by Japan's Ministry of Internal Affairs and Communications on Friday, the consumer price index (CPI) after excluding fresh food rose 1.6% year on year in June, in line with the median expectations obtained by market survey economists. Excluding fresh food and energy, the “core core CPI” — an indicator regarded by the Bank of Japan as a key reference for measuring potential inflation — rose 1.7% year over year, and overall CPI recorded the same increase.

The main driver behind the acceleration in inflation comes from energy costs. Although energy prices remain in a year-on-year decline due to government subsidies, the decline has narrowed sharply from the previous month. In addition, durable goods and medical expenses also contributed to the increase.

The above data reinforces the rationale for the Bank of Japan to continue to raise interest rates. The bank raised its benchmark interest rate to the highest level since 1995 last month. Meanwhile, the yen continued to weaken and fell overnight to a new low of more than 40 years, adding new concerns to policy makers already wary of the upward risk of inflation.

Despite this, the market generally expects the Bank of Japan to stand still at its next meeting on July 31. Policy makers usually tend to evaluate the impact of the last action before considering the next adjustments. At the same time, they must find a balance between high inflationary pressure and the loose policies favoured by Prime Minister Takaichi Sanae's government.

Taro Saito, head of economic research at the NLI Institute, said: “Today's data shows that there is no urgency for the Bank of Japan to raise interest rates drastically, but the recent weakening of the yen means that the central bank may have to act sooner rather than later.”

According to this week's survey, about half of Bank of Japan observers expect the next rate hike to be in December, and another 40% in October.

Economist Taro Kimura notes, “The depreciation of the yen may also drive up the prices of imported food and durable goods. Today's report should support the Bank of Japan in continuing to normalize monetary policy.”

Service prices — a key indicator for judging the sustainability of inflation — rose 1% year over year, the same as the previous month. Prices of food other than fresh food rose to their lowest level in nearly two years. Meanwhile, the price of rice fell 8.7% year on year, the biggest drop since 2015, while the price of rice soared 100% in the same period last year, which was one of the main drivers of overall inflation.

The cost of eating out continues to rise steadily, which is likely to reflect the impact of the weakening yen on import costs.

A weak yen will continue to put upward pressure on prices. The exchange rate of the yen fell below the 164 mark overnight, for the first time since 1986, further increasing the import costs of an economy that is highly dependent on overseas energy and food supplies.

Faced with the depreciation of the yen and higher investment costs driven by labor shortages, more large Japanese food and beverage companies are raising product prices. According to the Teikoku Databank report, the number of products planned to increase prices this month increased by nearly 22% compared to the same period last year, the first annual increase since 2026.

Since the outbreak of the war in Iran, Japanese companies have increasingly been tempted to pass on cost increases to customers rather than absorb them on their own, reflecting a shift in pricing behavior over a long period of time.

Multiple factors such as weak yen, hot weather, and rising fuel costs have pushed Japan's current electricity prices to the highest level in more than three years this week, which indicates the source of future inflationary pressure.

Although the Bank of Japan Policy Committee expects interest rates to remain unchanged at the end of this month, the latest quarterly economic forecast released at that time may reinforce the expected path of continuing interest rate hikes during the year.