Tokyo Core Inflation Slows Below 2%, Complicating BOJ Rate Hike Outlook

Annual core inflation in Tokyo eased in February, falling below the Bank of Japan’s (BOJ) 2% target for the first time in 16 months, highlighting potential tensions between the central bank and the government over future interest rate hikes. The latest data reinforces expectations that inflationary pressures in Japan may temporarily soften before regaining momentum later this year.

According to official figures released Friday, Tokyo’s core consumer price index (CPI), which excludes volatile fresh food prices, rose 1.8% year-on-year in February. This marked a slowdown from January’s 2.0% increase and came slightly above the median market forecast of a 1.7% gain. It was the first time since October 2024 that core inflation dipped below the BOJ’s 2% inflation target.

The moderation in Tokyo inflation was largely driven by government fuel subsidies, the removal of gasoline tax surcharges, and a slowdown in food price increases that had previously pushed consumer prices higher. However, a separate inflation measure that excludes both fresh food and fuel — closely monitored by the BOJ as a gauge of underlying price trends — rose 2.5% in February, up from 2.4% in January. This suggests that broader inflationary pressures remain relatively firm.

Economists note that the slowdown aligns with the BOJ’s projection that inflation would cool temporarily due to base effects and energy subsidies before reaccelerating on the back of steady wage growth. Analysts say the latest data alone is unlikely to derail the central bank’s commitment to gradually raising interest rates.

Still, political pressure may complicate the outlook. Prime Minister Sanae Takaichi has reportedly expressed caution about additional rate hikes during talks with BOJ Governor Kazuo Ueda, fuelling speculation of friction between monetary and fiscal authorities.

Meanwhile, separate government data showed Japan’s factory output rose 2.2%, marking the first increase in three months, driven by strong automobile production. However, the gain fell short of market expectations, and manufacturers anticipate weaker output in the coming months.

The BOJ raised its benchmark interest rate to 0.75% in December, a 30-year high, signalling confidence that Japan is moving toward sustainably achieving its 2% inflation goal. The central bank has indicated it stands ready to continue policy tightening if economic growth and inflation trends remain on track.