First time in 15 months! Japan Tokyo CPI falls below the 2% target, but the central bank's rate hike path remains unchanged

Tokyo’s capital inflation unexpectedly cooled, but analysts believe this slowdown is unlikely to prevent the Bank of Japan from further tightening monetary policy.

On Friday, Japan’s statistics bureau released data showing that the consumer price index (CPI) excluding fresh food in the Tokyo area rose 1.8% year-on-year in February, down from 2.0% in January, marking the first time since October 2024 that it fell below the BOJ’s 2% policy target. The main reason for this cooling is the government’s implementation of household subsidy policies, which caused energy prices to plummet 9.2% year-on-year.

However, several economists point out that underlying inflation pressures excluding energy remain robust, with service prices—highly correlated with wage growth—still rising. Overall, this data does not change market expectations regarding the BOJ’s monetary policy trajectory.

Market pricing currently indicates a nearly 60% chance of a rate hike by the BOJ in April, according to Tokyo short-term funding data from currency market brokers. The retail sales and industrial production figures released on the same day also show that Japan’s economy remains resilient, further supporting the case for rate hikes.

Energy subsidies drive the cooling, but core inflation remains supported

The decline in Tokyo’s CPI is not due to demand contraction or a reversal of inflation trends but mainly reflects technical suppression from government subsidies.

Data shows energy prices fell 9.2% in February year-on-year, which is the core factor pulling down overall CPI. The core inflation index excluding fresh food and energy rose from 1% in January to 2.5% in February, indicating that underlying price pressures have not eased.

Takuya Hoshino, an economist at Dai-ichi Life Research Institute, describes the Tokyo data as “generally solid,” noting that service prices increased 1.5% year-on-year, slightly higher than in January. Service prices are closely linked to wage increases and are an important indicator for the BOJ when assessing inflation sustainability.

Hoshino states that although CPI excluding fresh food continues to slow, “this result is unlikely to prevent the BOJ from further rate hikes.”

No change in rate hike path, April rate hike in sight

Many economists and market participants agree that the recent inflation slowdown has not substantially impacted the BOJ’s normalization process.

Marcel Thieliant, an economist at Capital Economics, said that based on a series of economic indicators released on Friday—including inflation data—“the BOJ is unlikely to wait too long before raising rates again.”

Since raising its policy rate to 0.75% in December last year, the BOJ has maintained a cautious yet proactive stance on rate hikes. Currently, traders and BOJ officials are closely monitoring Prime Minister Sanae Suga’s plans to implement consumption tax cuts, assessing their potential impact on future price trends.

Consumption and production data support economic resilience

Other economic data released on the same day show overall steady consumption and a rebound in production.

Japan’s retail sales in January increased 1.8% year-on-year, indicating sustained consumer momentum. Industrial output in January rose 2.2% month-on-month, sharply reversing the 0.1% decline in December, partly due to pre-holiday stockpiling before the Lunar New Year.

However, short-term recovery does not mean concerns have disappeared. The data also suggests that factory activity is expected to weaken again in the coming months. Continued manufacturing weakness could drag down broader economic growth, which would in turn weaken the case for further rate hikes.

On the international front, Japan’s manufacturing sector faces external pressures from two directions, adding uncertainty to the economic outlook.

Although the U.S. Supreme Court recently overturned the so-called reciprocal tariffs, Japanese officials warn that tariffs on the automotive industry are still weighing on related sectors and say they will continue to monitor the actual impact of the new tariffs introduced by the Trump administration. Policymakers believe that despite trade headwinds, Japanese companies remain resilient overall.

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