Tokyo Inflation Hits 3.6%, Pressuring BOJ to Act

Core inflation in Tokyo rose to 3.6% in May, the highest level in two years, as steady price increases in food and services pushed up the cost of living. The jump in prices is adding pressure on the Bank of Japan (BOJ) to consider an earlier interest rate hike than previously expected.

The core Consumer Price Index, which excludes fresh food, showed strong gains largely driven by persistent food inflation. The more refined core-core index, which also removes energy prices, increased by 3.3%. This measure is closely tracked by the BOJ and reflects a broader rise in prices across the economy.

Price growth has extended beyond goods. Inflation in the services sector reached 2.2% in May, indicating that businesses are successfully passing higher labor and operational costs on to consumers. As price pressures become more widespread, the likelihood of a near-term policy shift by the BOJ is rising.

However, this shift comes with complications. Factory output in Japan fell by 0.9% in April, pointing to continued weakness in manufacturing. The decline is partly attributed to falling global demand and the weight of recent U.S. trade tariffs on Japanese exports.

Japan’s Inflation Shift Challenges Policy Outlook

In response to rising inflation expectations, Japanese government bond yields have climbed to their highest levels since 2008. This reflects investor anticipation of tighter monetary policy. At the same time, rising borrowing costs pose risks for Japan’s economy, particularly due to the country’s already high public debt.

The BOJ now faces a delicate task:

It must address inflation that is no longer limited to external shocks but is increasingly driven by domestic factors.
At the same time, it must avoid choking off growth in an economy still recovering from global headwinds.

Markets will closely watch the BOJ’s next policy moves as it balances inflation control with the need to maintain stability in production and demand.

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