1.3%! Japan's February CPI Declines for Fourth Consecutive Month, Hitting 4-Year Low

Japan’s inflation continues to cool, making the Bank of Japan’s rate hike path increasingly complex.

On Tuesday, Japan’s Ministry of Internal Affairs and Communications released data showing that the February Consumer Price Index (CPI) rose 1.3% year-on-year, the lowest since March 2022, marking the fourth consecutive month of decline and falling below the BOJ’s 2% policy target.

Meanwhile, the core CPI excluding fresh food rose 1.6%, below market expectations of 1.7%, and for the first time in nearly four years, it fell below the 2% target.

The slowdown in inflation is mainly due to government fuel subsidy policies, but rising energy prices driven by Middle East conflicts pose new upside risks, adding greater uncertainty to the BOJ’s assessment of inflation trends. Last week, the BOJ kept its benchmark interest rate at 0.75% and warned of inflation upside risks stemming from Middle East tensions.

Core inflation falls below target, making rate hikes more difficult to time

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

Excluding fresh food and energy, core CPI rose 2.5% year-on-year, slightly down from 2.6% in January. The BOJ considers this measure a better indicator of demand-driven inflation.

According to Reuters, analysts expect that due to the continued impact of government fuel subsidies, core CPI will remain below 2% in the coming months. The government’s gasoline price control measures introduced this month are estimated by analysts to potentially lower core CPI by as much as 0.5 percentage points.

BOJ Governor Kazuo Ueda previously stated that if the central bank becomes more confident that inflation will stabilize near 2%, it is prepared to continue raising rates. Last week, he also said the BOJ will publish a new price indicator before summer, excluding one-off policy effects like fuel subsidies, to better gauge underlying inflation trends—some analysts see this as a move to justify further rate hikes.

Government policies and energy shocks, dual forces affecting inflation

Behind the inflation slowdown, active government intervention has played a key role. Prime Minister Sanae Sato promised during the campaign to suspend the 8% food tax for two years, and the government has introduced measures such as fuel subsidies to ease residents’ living costs. These measures have helped suppress inflation data but also make it harder for the BOJ to accurately assess underlying inflation levels.

Previously, the BOJ projected that, influenced by these policies, consumer price increases might fall below 2% in the first half of this year. For fiscal year 2026 (starting April 1), the BOJ forecasts core CPI and core “core CPI” at 1.9% and 2.2%, respectively.

At the same time, energy price shocks from Middle East conflicts exert reverse pressure. CNBC reports that Moody’s chief economist Stefan Angrick said the Middle East conflict is an “unsettling surprise,” with soaring commodity prices potentially causing supply shocks and pushing up inflation. “For a country like Japan that relies heavily on energy and food imports, this is bad news.” He also noted that if the conflict ends relatively quickly, the economic impact might be limited, but prolonged fighting would cause more severe damage.

Weak economic growth complicates policy decisions

The combination of slowing inflation and weak economic growth further constrains the BOJ’s policy options. Data shows Japan’s economy grew only 0.1% year-on-year in Q4 last year, a sharp slowdown from 0.6% in Q3, narrowly avoiding technical recession.

The BOJ plans to end its decade-long ultra-loose monetary policy in 2024 and has raised interest rates multiple times, including a rate hike in December last year, citing steady progress toward the 2% inflation target. However, the persistent decline in inflation data has made markets more cautious about the timing of the next rate increase.

Ongoing government price interventions continue to disturb inflation data, making it more challenging for the BOJ to gauge underlying inflation trends. Ueda’s initiative to introduce a new price indicator is seen by some analysts as an attempt to find clearer justification for rate hikes amid policy noise.

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