Tokyo inflation rose sharply in December, and with it rose the expectations of a Bank of Japan (BOJ) interest rate hike in early 2024.
Consumer prices in the Japanese capital increased by 3.0% year-over-year, up from 2.6% in November, according to government data.
Core inflation, which excludes fresh food and energy costs, rose to 2.4% from 2.2% the previous month.
The BOJ, which has maintained an ultra-loose monetary policy for years, is now finally seeing signs that inflation may be sustainable.
While the rest of the world is still in the fight against higher inflation figures, Japan is now considering whether a tighter policy will be the way forward.
Inflation drivers: key factors
Energy prices were a key driver of Tokyo’s December inflation increase.
The end of government subsidies for gas and electricity in late 2023 led to a sharp 13.5% rise in energy costs.
These subsidies, however, are set to return from January through March 2024, likely distorting inflation figures in the months ahead.
Source: Bloomberg
Services prices rose by 1.0% in December, up slightly from 0.9% in November.
Economists view this as a sign that higher wages are beginning to push up prices in the service sector.
Wage increases, supported by a tight labour market, could further strengthen inflationary pressures.
The jobs-to-applicants ratio remained steady at 1.25 in November, meaning there were 125 jobs available for every 100 job seekers.
Is Japan ready for a rate hike?
The latest inflation figures align with the BOJ’s 2% inflation target, a benchmark the central bank has long struggled to meet consistently.
However, the December data suggests that the BOJ may finally see enough momentum to justify further policy normalization.
Governor Kazuo Ueda has indicated that the BOJ will base its next steps on incoming data, including wage trends and global economic conditions.
The Tokyo CPI figures act as a leading indicator for nationwide inflation.
With Japan’s nationwide CPI hovering near multi-decade highs, the BOJ has already ended its negative interest rate policy and moved its short-term rate to 0.25%.
Analysts are now forecasting at least one rate hike early in 2024, possibly at the BOJ’s January or March meeting.
Japanese economy: mixed signals
While inflation and labour market conditions suggest that the BOJ might hike rates, other economic data paint a different picture.
Factory output fell by 2.3% in November, marking the first decline in three months.
Weak global demand, particularly for semiconductor equipment and automobiles, has weighed on Japan’s export-reliant economy.
Retail sales, however, provided a glimmer of strength, rising 1.8% in November compared to the previous month.
Year-on-year growth was 2.8%, slightly above the inflation rate, driven by increased spending on clothing and consumer goods.
How will yen react?
The Japanese yen has been under pressure, trading near a five-month low against the US dollar.
The USD/JPY pair recently hovered around 157.70, down from a monthly high of 158.08.
A weaker yen has fuelled inflation by increasing import costs, particularly for energy and raw materials.
Currency movements remain a key consideration for the BOJ.
Finance Minister Katsunobu Kato has warned against sharp, one-sided moves in foreign exchange markets and hinted at potential interventions if the yen’s depreciation accelerates.
Will BOJ hike rates?
The BOJ’s next monetary policy meeting on January 23-24 is shaping up to be a kye event for Japan’s economic outlook in 2025.
Analysts are divided on whether the central bank will move quickly to raise rates or wait for more clarity on wage growth and global economic trends.
One factor to watch is Japan’s annual wage negotiations, which typically conclude in the first quarter.
If wages show significant growth, the BOJ could feel more confident about the sustainability of its inflation target.
Governor Ueda has repeatedly emphasized that durable wage-driven inflation is a critical prerequisite for further tightening.
Japan’s evolving monetary policy could affect global markets.
The BOJ has been a key source of liquidity for global financial markets due to its long-standing commitment to low rates.
A shift toward higher rates in Japan could tighten liquidity and influence bond yields worldwide.
Additionally, the yen’s movements could have far-reaching implications for global trade.
A stronger yen might reduce Japan’s export competitiveness, while a weaker yen could exacerbate global inflation through higher import costs.
Tokyo’s inflation rise signals that Japan’s long battle with deflation may be turning a corner.
While higher energy prices and a tight labour market point to a potential rate hike, other economic data alongside global risks make the BOJ’s decision anything but straightforward.
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