Data released by Japan's Ministry of Internal Affairs and Communications on Friday showed that the nationwide core Consumer Price Index (CPI), which excludes fresh food, rose 1.4% year-on-year in April. This figure not only fell short of the market expectation of 1.7% but also marked a significant decline from the 1.8% recorded in March, reaching its lowest level since March 2022. The overall CPI also came in at 1.4%, below the expected 1.6%. This indicates that Japan's inflation rate has remained below the central bank's 2% policy target for the fourth consecutive month. Following the data release, the USD/JPY exchange rate briefly rebounded to around 159, with a relatively restrained market reaction.
While inflation data weakened, the hawkish faction within the Bank of Japan is gathering at a pace exceeding market expectations. On the surface, the April inflation data showed a "broad-based cooling" – the overall CPI fell to 1.4%, the core CPI fell to 1.4%, and the "core-core CPI" (excluding fresh food and energy prices), which better reflects underlying demand-side price changes, rose 1.9% year-on-year, down from 2.4% in March, hitting a 14-month low. However, a breakdown of the structural details behind the data reveals that inflationary pressures are far from subsiding.
First, the decline in inflation is not due to shrinking demand but rather the result of strong policy intervention. Government measures such as tuition subsidies have suppressed one-time expenditure items like private high school fees, while energy subsidies continue to buffer the transmission of international oil prices to end consumers. Once these subsidies are withdrawn, the suppressed prices are likely to rebound at a faster pace.
Second, as a leading indicator for consumer prices, the Corporate Goods Price Index (CGPI) had already surged 4.9% year-on-year in April, hitting a three-year high. Import prices rose 17.5% year-on-year, with energy prices and a weaker yen jointly driving up imported inflation. Bank of Japan board member Junko Nakagawa pointed out that the speed at which companies are passing on costs through price increases is "significantly faster" than in the past, a judgment entirely consistent with the remarks made earlier this week by BOJ Governor Kazuo Ueda.
Third, a more hidden structural variable comes from the AI industry. On May 21, BOJ board member Junko Onoda explicitly warned in a speech to business leaders in Fukuoka that strong AI demand might be pushing up energy prices, suggesting that "prices for many goods could rise across the board in the future." As a key player in the global AI supply chain, Japan benefits from the AI-driven semiconductor export boom (chip exports surged 44% year-on-year in April) but also bears the incremental electricity demand from AI data centers. This incremental demand, coupled with energy supply disruptions in the Middle East, creates a "pincer attack" that subjects Japan, an economy highly dependent on energy imports, to unprecedented inflationary complexity.
Furthermore, affected by turmoil in the Middle East, Japan's crude oil imports in April plummeted 64% year-on-year. The reduction in total energy import value, in terms of data, actually lowered the overall inflation reading. In other words, part of the "credit" for the lower April CPI comes from a physical contraction on the supply side, not a cooling of demand – a contradiction that itself suggests the potential for a future inflation rebound is building.
Fiscal "Pivot": Supplementary Budget and Energy Subsidies Shake Government Bond Pricing On May 18, Japanese Prime Minister Sanae Takaichi announced at a government and ruling party liaison meeting that she had instructed Finance Minister Tsuyoshi Katayama to study the formulation of a supplementary budget for fiscal year 2026 to mitigate the impact of persistently high energy prices, caused by the prolonged situation in the Middle East, on the economy and people's lives. The backdrop for this decision is clear and urgent: as the Middle East conflict continues, Brent crude oil is trading above $110, global commercial oil inventories are "declining sharply," and Japan's oil inventories are down 50% from their peak, the lowest for the period in at least a decade. For Japan, which relies almost 100% on imported energy, every 10% increase in oil prices consumes about 0.3 percentage points of GDP due to deteriorating terms of trade.
The Japanese government has been suppressing retail gasoline prices below 170 yen per liter for several weeks through subsidies, subsidizing about 42.6 yen per liter. The related fund is expected to be depleted by the end of June. Prime Minister Takaichi has called for the formulation of electricity and gas subsidy plans for July to September to ensure energy costs this summer are lower than last year's levels and to restart consumer energy subsidies of about 280 billion yen. The government plans to allocate about 500 billion yen from the 1 trillion yen reserve in the fiscal 2026 budget for energy subsidies. However, facing the pressure of fund depletion by the end of June, formulating a supplementary budget on the scale of trillions of yen has almost become a certainty.
The market's reaction was swift and severe: following the news, "selling Japan" trades re-emerged. The yield on Japan's 10-year government bond briefly rose to 2.8% on May 18, hitting a roughly 30-year high since October 1996. The 30-year bond yield broke above 4.2%, and the 40-year bond yield rose to 4.345%, both setting record highs. Since Sanae Takaichi became the president of the Liberal Democratic Party in October 2025, the yield on Japan's 10-year government bond has climbed cumulatively by over 1.1 percentage points from about 1.66% to above 2.7%, with the 30-year yield rising significantly in sync from about 3.15%. The Nikkei 225 index plunged over 1,000 points on May 15, with the Japanese market experiencing a rare pattern of "triple sell-off" in stocks, bonds, and the yen – all falling simultaneously. Daisuke Uno, chief strategist at Sumitomo Mitsui Banking Corporation, stated bluntly: "Countries like Japan and the UK, once they consider fiscal stimulus measures, often trigger simultaneous selling of stocks, currency, and bonds because these countries have weak economic growth and relatively high inflation risks."
The market's "sell-off" response to the Takaichi government's latest decision stems from three underlying concerns. The first is Japan's already extreme fiscal burden. The total budget for fiscal 2026 reached a record 122.31 trillion yen, with government debt exceeding 250% of GDP, the highest among major developed countries. The second is Japan's difficult transition from ultra-low interest rates to a "positive rate repricing" phase. The Bank of Japan, as the largest past buyer of Japanese government bonds, is exiting its extreme easing policy, leading the market to demand a higher term premium. The third and most crucial concern is the directional conflict between fiscal and monetary policy becoming apparent. As Mari Iwashita, interest rate strategist at Nomura Securities, pointed out, "For a country with high debt like Japan, expanding fiscal spending while the central bank gradually exits easing is tantamount to sending a signal to the market of 'raising rates with the left hand while borrowing with the right hand.' Long-term government bond yields are repricing this."
Facing market pressure, Sanae Takaichi attempted to alleviate concerns about runaway debt. In a party debate on May 20, she stated, "It is expected that there will be a surplus in the account next month or the month after, so it is not necessarily required to issue a large amount of government bonds," emphasizing that "the government intends to protect people's lives and business operations while minimizing government bond issuance as much as possible." However, whether the expectation of a fiscal surplus materializes largely depends on the government's ability to find sufficient non-debt revenue sources. If funds for the supplementary budget are raised by issuing "deficit-covering bonds," the pressure on the bond market will be substantial. Ma Tieying, an economist at DBS Group Research, noted, "Expectations for a supplementary budget are reigniting the so-called 'Takaichi trade' – expectations of increased government bond supply are pushing up Japanese government bond yields and putting pressure on the yen."
June 15-16: How Will the Bank of Japan Decide? The April CPI falling to 1.4% and the probability of a June rate hike rising to 70%-80% – these seemingly contradictory data points precisely reveal the deep-seated logic of Japan's current economic policy. The Bank of Japan faces a classic policy dilemma: on one hand, economic growth is slowing (the GDP growth expectation for fiscal 2026 has been revised down from 1.0% to 0.5%), and a rate hike could suppress a recovery that is not yet solid. On the other hand, while core inflation appears to be softening on the surface, imported pressures are continuously building – the US-Iran conflict pushing up energy costs, AI demand accelerating electricity consumption, companies accelerating the pass-through of wage and raw material costs, and yen depreciation persistently amplifying import price effects.
Governor Kazuo Ueda, at a press conference following the April meeting, explicitly stated that the BOJ would avoid "falling behind the curve" in the fight against inflation and emphasized that a rate hike is "a realistic possibility" if the economy does not slow significantly. Simultaneously, the Bank of Japan must also weigh external factors: explicit pressure from the US to raise rates, global bond markets demanding higher term premiums, and market concerns about the sustainability of Japanese government bonds pushing long-term yields to 30-year highs. Under this "pincer attack" from both internal and external forces, merely maintaining a 0.75% interest rate can hardly meet the expectations of all parties.
The Bank of Japan will hold its next monetary policy meeting on June 15-16. At that time, the nine-member board will face not just an interest rate decision but a systemic choice of how to balance between economic slowdown, fiscal expansion, international oil price shocks, and yen depreciation. The judgment of Li Huihui, Professor of Management Practice at Emlyon Business School, is quite representative: "Japan is switching from a long-term state of low inflation and low interest rates to a 'positive rate repricing' stage – this is not a short-term fluctuation but an overall elevation of the term interest rate center."
From inflation data to central bank decisions, from fiscal expansion to the government bond market, from yen intervention to US pressure – Japan's economy in 2026 is engaged in a game on multiple fronts simultaneously. The tension between the "weakening" of April inflation data and the "strengthening" of June rate hike expectations indicates that the Bank of Japan remains highly vigilant about the temporary decline in CPI. Behind the 1.4% figure, underlying forces are driving the world's fourth-largest economy into an unprecedented experiment in policy normalization.
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