Japan's June Core Inflation Edges Up From Four-Year Low, Driven by Higher Oil Prices

Data released by the Japanese government on Friday showed that Japan's core inflation rate in June was 1.6%, edging up from a four-year low as higher oil prices rippled through the broader economy.

This marks the first increase in core inflation since March, aligning with the 1.6% growth forecast by economists polled by Reuters. Japan's core inflation indicator excludes fresh food prices.

The headline inflation rate rose to 1.7% from 1.5% in May. Meanwhile, the "core-core inflation" rate, which strips out both fresh food and energy prices, fell back to 1.7%, its lowest level since August 2022.

Thanks to government subsidies that cushioned the impact, energy prices in June fell only slightly year-on-year by 0.1%, compared to a 2.5% drop in May. Utility costs for fuel and electricity remained flat, ending a six-month streak of declines.

While Japan has introduced subsidy policies to mitigate the impact of global energy price hikes on households, costs on the business side have risen significantly. The country's Producer Price Index (PPI) surged to 7.1% in June, its highest level since March 2023.

Tokuhiro Yamaguchi, Chief Japan Economist at Oxford Economics, pointed to the PPI data, noting that due to policy offsets, current inflation figures do not yet show strong underlying domestic price pressures, but upstream cost pressures are building.

"We expect core-core CPI inflation to pick up again later and could reach around 3% by early 2027," he added.

Japan continues to face pressure from high oil prices as the Middle East conflict disrupts energy supplies. This is compounded by the persistent weakness of the yen, which further raises import costs.

Trade data released on Wednesday showed that the value of Japan's oil imports surged by more than 59% year-on-year, driven by higher costs. Data from the International Energy Agency indicates that Japan relies on imports for over 87% of its energy needs.

With the yen remaining at multi-decade lows, markets are concerned that Japan will face more severe imported inflation. The dollar stood at 163.82 yen on Friday. Following the data release, Japan's Nikkei 225 index fell by 2.14%.

Citing sources familiar with the Bank of Japan's (BOJ) thinking, a media report on Wednesday stated that the central bank is "on alert for upside inflation risks and does not rule out raising interest rates at a faster pace than the market expects."

The report added that some BOJ officials believe there is a possibility of accelerating rate hikes if price pressures from a weak yen and rising fuel costs due to the Iran conflict push inflation up faster than anticipated.

Yamaguchi from Oxford Economics stated that the BOJ is in a dilemma. The foreign exchange market is putting continuous pressure on the central bank to raise rates earlier, fearing the BOJ is falling behind the curve.

However, he also noted that as policy rates move closer to the neutral rate, the Japanese government is becoming more cautious about further rate hikes. Oxford Economics estimates Japan's neutral interest rate to be 1.5%.

"Our base case remains a rate hike in December. However, if the situation of high oil prices combined with a weak yen persists, an October rate hike could also become an option," he concluded.