Data released on Friday (February 21) showed that Japan's core consumer price index (CPI) for January rose by 3.2% year-on-year, reaching a new high in 19 months. This data enhances market expectations that the Bank of Japan will continue to raise interest rates, despite the current low interest rate levels.

Data performance and market response

The year-on-year increase in core CPI in January was higher than the market forecast of 3.1%, while the increase in December was 3.0%. After the data was released, bond yields rose, reflecting market expectations that the Bank of Japan may increase its interest rate hikes. The yield of two-year Japanese treasury bond rose 1.0 basis points from Wednesday to 0.830%, the highest level since October 2008.

Ryosuke Katagi, a market economist at Mizuho Securities, said, "Although service sector inflation has not significantly accelerated, commodity inflation has not slowed down either. The Bank of Japan may consider price trends to be consistent with its predictions, and therefore may further raise interest rates

Inflation drivers

The CPI, which excludes fresh food and fuel costs and is closely monitored by the Bank of Japan, rose by 2.5% year-on-year in January, the fastest growth rate since March 2024. Data shows that fuel and food prices remain high, with energy costs rising by 10.8% in January, while prices of food such as rice and vegetables continue to rise. This has raised doubts in the market about whether cost driven inflationary pressures will dissipate.

In contrast, the inflation rate of the service industry in January was 1.4%, which slowed down from 1.6% in December. However, the Bank of Japan believes that steady wage growth will encourage service industry companies to shift labor costs and become the main driving force for future inflation.

Economic background and policy outlook

The Japanese economy grew at an annual rate of 2.8% in the fourth quarter of last year, thanks to strong performance in corporate spending and consumption. This provides support for the Bank of Japan to further raise interest rates. Bank of Japan Governor Kazuo Ueda stated that if wage growth continues to support consumption and allows businesses to continue raising wages, he will be prepared to further raise interest rates.

The Bank of Japan raised its short-term interest rate from 0.25% to 0.5% in January, demonstrating its confidence in achieving its 2% inflation target. In the past three years, Japan's inflation rate has consistently exceeded this target, highlighting the continued rise in inflationary pressures.

Market expectations

Most economists surveyed by Reuters expect the Bank of Japan to raise interest rates again this year to 0.75%, most likely in the third quarter. This expectation echoes the hawkish rhetoric of decision-makers such as Bank of Japan's deliberation committee member Chuang Takada.

summary

The strong performance of Japan's core CPI in January has strengthened the market's bet on the Bank of Japan continuing to raise interest rates. Although inflation in the service industry has slowed down, rising commodity inflation and energy costs still exert pressure on inflation. With the support of stable economic performance and wage growth, the Bank of Japan may further tighten monetary policy in the coming months to cope with ongoing inflationary pressures.