Rampant Inflation Strikes Japan's Capital: Economic Turmoil Imminent, Monetary Policy at Stake

Rising Inflationary Pressure Threatens Japan’s Economy

Core consumer inflation in Tokyo, the leading indicator of nationwide trends, has slowed in May, but a key index excluding fuel costs has skyrocketed to a four-decade high. These alarming figures highlight the deepening price pressure in Japan, raising concerns about the longevity of ultra-loose monetary policy.

The Tokyo core consumer price index (CPI), which accounts for fuel costs but excludes volatile fresh food, surged by 3.2% in May compared to the previous year. This growth closely aligns with the market forecast of a 3.3% increase. Although the inflation rate decelerated from the previous month’s 3.5%, it has remained above the Bank of Japan’s (BOJ) 2% target for a full year. The consistent rise in food prices has offset the decline in fuel costs, maintaining elevated inflation levels.

BOJ’s Ultra-Loose Policy on Thin Ice as Inflation Overshoots Expectations

The index, excluding both fresh food and fuel costs, experienced an alarming surge of 3.9% in May compared to the previous year. This represents the highest pace of increase since April 1982, during Japan’s asset-inflated bubble period. The BOJ’s inflation forecasts have already been surpassed, indicating that the prospects of higher wages are compelling companies to pass on rising labor costs through price hikes.

Takuya Hoshino, chief economist at Dai-ichi Life Research Institute, warns, “Inflation already appears to be overshooting the BOJ’s forecasts. Prospects of higher wages are prodding more firms to pass on rising labor costs through price hikes.” He suggests that depending on the upcoming data, the BOJ may be forced to respond to elevated inflation by adjusting its ultra-loose policy.

The price service companies charge each other also rose by 1.6% in April compared to the previous year, marking the 26th consecutive month of gains. As the economy reopens from pandemic restrictions, the surge in tourism demand has contributed to this upward trend in prices.

The recovery of Japan’s economy from the scars of the COVID-19 pandemic is marred by the risks of a global economic slowdown and rising food prices. With inflation already surpassing the BOJ’s target, speculations are rampant that the central bank, under the new governor Kazuo Ueda, may soon phase out its ultra-loose monetary policy.

Ueda has repeatedly emphasized that inflation will slow in the coming months as cost-push factors dissipate. He asserts that the BOJ will maintain the ultra-loose policy until substantial wage growth ensures sustainable achievement of the 2% inflation target. However, Ueda also warns that the BOJ will “act swiftly” if their inflation projection proves incorrect and may modify policy if the cost of stimulus outweighs its benefits.

More than half of the surveyed analysts expect the BOJ to initiate the unwinding of its yield curve control (YCC) policy by the end of July. This could involve raising the current 0.5% cap for the 10-year government bond yield. The BOJ will review its quarterly growth and inflation forecasts during a two-day policy meeting concluding on July 28.

In April, the central bank projected core consumer inflation to reach 1.8% in the current fiscal year ending in March 2024. However, a poll conducted by the Japan Center for Economic Research in May forecasts a lower rate of 2.3%, indicating a less optimistic outlook.

Rampant Inflation Strikes Japan’s Capital: Economic Turmoil Imminent, Monetary Policy at Stake

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