Japan's core inflation in July rose 3.1% year-on-year, far exceeding the central bank's 2% target

Japan's inflation level remained stubborn in July, with rising prices of food items like rice intensifying expectations for interest rate hikes by the Bank of Japan.

On August 22, the Japanese government officially announced that its core Consumer Price Index (CPI) in July increased by 3.1% year-on-year. Although this was a slowdown from June's 3.3%, it still exceeded market expectations of 3.0% and the Bank of Japan's target of 2%.

The slowdown in core inflation data was mainly due to a decline in energy prices, which fell by 0.3% year-on-year in July, marking the first decrease since March 2024.

However, Japan's inflation momentum remains strong. A "core-core" indicator that excludes fresh food and energy prices, which is considered to more accurately reflect underlying inflation trends, showed a year-on-year increase of 3.4% in July, unchanged from the previous month.

Following the data release, the market reacted swiftly. Japanese government bond yields rose sharply, while swap contracts reflecting market expectations indicated that traders believe the probability of the Bank of Japan raising interest rates before the end of October has climbed from about 42% a month ago to 51%.

Yoshiki Shinke, a senior executive economist at Dai-Ichi Life Research Institute, pointed out that "it is a mistake to conclude that inflation is weakening just because core CPI has slowed." He emphasized that food prices are still accelerating, reflecting companies' willingness to pass costs onto consumers.

Price Increase Momentum Unabated, Is Rice the "Culprit"?

The price of rice in Japan continues to soar. Data shows that rice prices increased by 90.7% year-on-year in July, although this was a decrease from June's 100.2% increase, it remains at an extremely high level.

The surge in the price of this staple food has sparked strong dissatisfaction nationwide. Record high temperatures threaten crop yields, potentially leading to new supply shortages and dashing hopes for price declines.

The chain reaction from rising rice prices is evident. Processed food prices rose by 8.3% year-on-year, marking the fastest growth since September 2023. The service sector's price increase remained at 1.5%, unchanged from the previous month.

ING economists analyzed that the continuously rising rents and soaring rice prices are being transmitted to the prices of processed foods and dining out. According to a report from Teikoku Databank, it is expected that in August, major food and beverage companies in Japan will raise prices on 1,010 products. The ongoing pressure of living costs has also brought significant political pressure to Prime Minister Shigeru Ishiba's government.

Interestingly, opinions among netizens regarding the impact of rice on CPI vary. Some netizens pointed out that rice only accounts for about 0.6% of the Japanese Consumer Price Index (CPI) basket, resulting in a pull effect of less than 1%. However, others argue that the exponential increase in rice prices means that even a 0.6% pull effect is substantial

Rising Expectations for Interest Rate Hikes

Supported by inflation data and strong economic growth figures, market expectations for interest rate hikes by the Bank of Japan are rapidly increasing. Data released last week showed that the Japanese economy has grown for five consecutive quarters.

Several economists believe that the window for interest rate hikes is approaching. Abhijit Surya, a senior economist at Capital Economics, wrote in a report that with good economic performance and reduced uncertainty related to tariffs, "the Bank of Japan should feel reassured about quickly restoring policy normalization," and believes that the possibility of a rate hike in October still exists.

Bloomberg economist Taro Kimura also stated that the data supports the Bank of Japan taking a "gradual interest rate hike path." Although Governor Kazuo Ueda has repeatedly assured that the central bank is not "behind the curve," market participants, including U.S. Treasury Secretary Scott Bessent, have publicly stated that the Bank of Japan has been slow to act in response to inflation. Currently, the market generally expects the Bank of Japan to remain on hold at the September meeting, but the October meeting is becoming a key focus for all parties.

This series of dynamics comes as Bank of Japan Governor Kazuo Ueda prepares to attend the global central bank annual meeting, where investors will closely watch for any statements regarding future policy paths.

However, Zerohedge sarcastically remarked, "The Bank of Japan will eventually realize that raising interest rates does nothing to increase rice production."