Japan's key inflation gauge accelerated for the first time in five months, driven by factors including a smaller decline in gasoline prices, signaling that price pressures are building even before the full impact of rising oil prices has filtered through the economy. Data released by the Ministry of Internal Affairs and Communications on Friday showed the core Consumer Price Index, which excludes fresh food, rose 1.8% year-on-year in March. This figure exceeded economists' expectations of 1.7% and was higher than the 1.6% increase recorded in February.
The "core-core CPI," a measure closely watched by the Bank of Japan as an indicator of underlying inflation that excludes both fresh food and energy, increased 2.4% year-on-year, remaining above the central bank's 2% target. The headline CPI, which includes all items, rose 1.5%.
Japan is currently facing a dual challenge of high oil prices and persistent yen weakness, which are pushing up import costs. Reports this week citing informed sources suggest that due to uncertainties stemming from conflict in the Middle East, the Bank of Japan is leaning toward keeping its benchmark interest rate unchanged at its policy meeting. However, pricing in the overnight swap market indicated that as of Friday, traders saw a 67% chance of a rate hike.
It is important to note that Friday's inflation data may not yet fully reflect the recent surge in energy prices. In mid-March, gasoline prices in Japan hit a record high before government subsidies were reintroduced to cap prices. In the latest report, gasoline prices fell 5.4% year-on-year, a much smaller decline compared to the 14.9% drop in the previous month.
A senior executive economist noted that gasoline and kerosene were core factors pushing the index higher, but the effect of government subsidies introduced in late March is expected to reduce their contribution in the next data release. Another economist pointed out that the hotter-than-expected March CPI was driven by a first wave of inflation from rising oil prices due to supply constraints. Weakness in the yen is also elevating prices for goods, reflecting higher import costs, with an expectation for a rate hike.
Crude oil prices are significantly higher than pre-conflict levels, posing a major challenge for Japan, which relies almost entirely on imported oil. A separate services producer price index released by the Bank of Japan showed a 3.1% increase in March, partly reflecting the impact of Middle East tensions, with overseas freight costs surging. On a month-on-month basis, the services producer price index saw its largest increase in nearly 36 years.
Economists warn that if crude prices remain at current high levels or rise further, controlling inflation will become more difficult. The Bank of Japan is reportedly considering a significant upward revision to its inflation forecast in its upcoming quarterly outlook. The central bank governor has emphasized the need to assess both upside and downside risks to underlying inflation, with a market survey showing about three-quarters of economists believe risks are skewed to the upside.
In the two months since the conflict began, several major Japanese food companies have announced price hike plans, indicating that price pressures could continue to spread even if an oil crisis dampens demand. In March, processed food prices rose 5.2%, slightly slower than the previous month, while rice prices, which surged a year ago, increased 6.8%. Prices for household durable goods rose 4.3%, reversing a previous decline, while accommodation price increases slowed. Service prices, a key gauge of demand-driven inflation, remained stable.
In summary, high oil prices and a weak yen are tilting inflation risks to the upside. Businesses have begun raising producer prices, and the focus now shifts to how these increased costs will be passed on to consumers.
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