Japanese 'core-core' inflation continues downward trend

The growth in Japanese consumer prices accelerated sharply in May but underlying inflation slowed more than expected, adding uncertainty to the interest-rate outlook.

The annual rate of consumer price inflation rose to a three-month high of 2.8% last month, up from 2.5% in April and in line with forecasts. Core inflation, which includes fuel prices but excludes the cost of food, rose to 2.5% from 2.2%.

However, the so-called 'core-core' rate, which excludes both energy and food, fell more than economists' estimates to 2.1% from 2.4%. This was the ninth straight decline in underlying inflation and the lowest reading since September 2022.

The Bank of Japan exited its negative-rate strategy in March, and was widely expected to raise rates again this summer with inflation having stayed above the 2% target for more than two years. The BoJ is hoping that recent pay hikes in the Spring wage negotiations would spur consumer spending and keep inflation at target over the short to medium term.

However, the sharp slowdown in the core-core rate – from a decades-long peak of 4.3% in August 2023 – continues to cloud the outlook for rates.

"Inflation is in focus, for most of the world we are watching disinflation take hold so that central banks can cut rates, not so in Japan. Friday’s national CPI release was expected to give a green light to a rate hike in July, however, inflation surprised on the downside," said Kathleen Brooks, research director at XTB.

Meanwhile, Brooks said there are signs that the Japanese economy is "losing some steam", with the closely watched Jibun Bank-S&P Global purchasing managers' index surveys for June which showed that growth slowed in the manufacturing sector and turned negative in services.

"This has had an immediate impact on the yen, and USD/JPY surged to 159.00 at one point on Friday, it is currently trading just below this level, which may trigger official FX intervention to strengthen the yen. While the BoJ will likely hike rates next month, the BoJ will not want to spook the domestic economy by sounding too hawkish, which is weighing on the yen."