Inflation in Tokyo has unexpectedly cooled again, tempering market expectations for an imminent rate hike by the Bank of Japan and causing the yen to weaken toward the 160 level.
Data released by Japan's statistics bureau on Tuesday showed that Tokyo's headline CPI rose 1.4% year-on-year in March, the slowest pace since March 2022. Core CPI (excluding fresh food) rose 1.7%, below the estimated 1.8%, further falling below the Bank of Japan's 2% annual target.
The lower-than-expected inflation data, coupled with economic uncertainty fueled by Middle East tensions, has significantly dampened expectations for an immediate rate hike by the Bank of Japan. Following the release, the USD/JPY exchange rate received buying support, approaching the 160 mark intraday.
Bloomberg economist Taro Kimura noted that the Bank of Japan remains alert to oil prices driving up inflation and, by extension, medium- to long-term inflation expectations. The possibility of a 25-basis-point rate hike in April remains, as previous policy normalization has not significantly weighed on growth.
<h2>Inflation Cools Across the Board, Core Metric Hits 13-Month Low</h2>
March inflation data for Tokyo showed a broad-based deceleration.
Headline CPI fell from a revised 1.5% in February to 1.4%, while the core-core metric (excluding fresh food and energy) dropped from 2.5% to 2.3%, the slowest growth in 13 months and a key reference for the Bank of Japan in measuring underlying inflation.
This cooling largely reflects a narrowing of price increases for processed foods, which slowed from 5.5% last month to 4.9% in March.
Regarding energy, overall energy prices fell 7.5% year-on-year, a slightly narrower decline than February's 9.2%. Specifically, the decline in gasoline prices narrowed sharply from 14.7% in February to 1.0%. The data collection for Japan's statistics took place around mid-March, just as geopolitical tensions began to exert upward pressure on oil prices.
Service price growth remained steady at 1.5% year-on-year, while the rise in rice prices moderated significantly from 18.2% last month to 8.3%.
The continued cooling of inflation in Japan is also closely linked to the Sanae Takaichi government's policy measures to control utility and food prices. Analysts expect the Japanese government to maintain these subsidy measures in the near term to counter Middle East energy price shocks.
<h2>Middle East Tensions Signal Potential Inflation Rebound</h2>
Despite the current soft data, several parties have warned that future inflation faces significant upside risks.
Kohei Okazaki, Chief Market Economist at Nomura Securities, stated:
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The impact of the situation in the Middle East will gradually manifest. If international oil prices remain at current levels, headline inflation could rise to between 2.5% and 3% in the second half of this year.
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Kohei Okazaki added:
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If the yen weakens further, there could even be moments where inflation exceeds 3% in the second half of the year.
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The Bank of Japan previously signaled a temporary dip in inflation and expects it to rebound later this year as the effects of government subsidies fade and wages rise further. The central bank clearly outlined its subsequent rate hike path in its policy statement, with the next meeting scheduled for April 28.
A report from Teikoku Databank on Tuesday showed that food and beverage companies will raise prices on nearly 2,800 items in April, the largest scale of hikes since last October.
Another report from the agency showed that over 1,500 Japanese companies operating in the Middle East face direct risks from supply chain disruptions and rising raw material costs, involving a wide range of imports such as marble, fish feed, and lubricants.
<h2>Other Economic Data Highlight Weak Domestic Demand</h2>
Other economic data released on Tuesday further highlighted the pressures facing Japan's domestic demand.
Data showed that Japan's industrial production in February fell 2.1% month-on-month, slightly worse than the market expectation of a 2.0% decline, and rose only 0.3% year-on-year. Manufacturers expect output to rebound by 3.8% in March and grow a further 3.3% in April, but Kohei Okazaki noted:
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These forecasts were based on a survey conducted on March 10, so the impact of the Middle East situation is not yet fully reflected.
</blockquote>
Consumption also remained weak. Retail sales fell 2.0% month-on-month in February and declined 0.2% year-on-year.
The labor market, however, showed resilience. Data from the Ministry of Health, Labour and Welfare showed the unemployment rate fell slightly to 2.6% in February, while the job-to-applicant ratio rose marginally to 1.19, meaning there were 119 job openings for every 100 seekers.
A persistently tight labor market provides support for wage growth, which remains a key pillar for the Bank of Japan's expectations of a continued rate hike path.

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Tokyo's headline CPI grew 1.4% year-on-year in March, marking the slowest growth since March 2022. Core CPI (excluding fresh food) rose by 1.7%, missing the expected 1.8% and further undershooting the Bank of Japan's 2% annual target. Despite the current soft data, analysts warn of significant upside risks for future inflation, and the possibility of a 25-basis-point rate hike in April remains on the table

- Tokyo's inflation data unexpectedly cooled, weakening expectations for a near-term interest rate hike by the Bank of Japan as the yen approached 160 against the dollar.  
- The overall CPI rose 1.4% year-on-year in March, marking the lowest growth since March 2022, while core CPI excluding fresh food increased by only 1.7%, below expectations and the BOJ's 2% target.  
- Despite current soft data, experts warn that inflation may rise later in the year due to geopolitical tensions affecting oil prices, with predictions of possible increases in the overall inflation rate to between 2.5% and 3%.

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Tokyo's March CPI Cools Again to a Four-Year Low, But BOJ Rate Hike Expectations for April Remain