Japan's core inflation hit 3% in February, BoJ rate hike expectations remain

Japan's core inflation hit 3.0 percent in February and the index excluding the effect of fuel rose at the fastest pace in nearly a year, a sign of growing price pressures that reinforced market expectations for further interest rate hikes.

After the Bank of Japan decided to keep interest rates unchanged on Wednesday, Governor Kazuo Ueda warned that rising food costs and stronger-than-expected wage growth could push up underlying inflation.

The core consumer price index (CPI), which strips out the impact of volatile fresh food costs, rose, compared with a median market forecast for a 2.9% increase. That kept core inflation above the Bank of Japan’s 2% target for 35 straight months.

The increase slowed from 3.2% in the previous month due to the restoration of subsidies to curb fuel costs, government data showed on Friday. A separate index closely watched by the Bank of Japan, which excludes the impact of fresh food and fuel costs and is a broader price trend indicator, rose 2.6% in February from a year earlier after rising 2.5% in January. This is the fastest annual growth rate since March 2024, when it increased 2.9%.

"The strength of underlying inflation in February suggests the Bank of Japan is likely to raise rates at its next meeting in May, but we continue to expect uncertainty over the impact of U.S. tariffs to delay a hike until July," said Marcel Thieliant, head of Asia Pacific at Capital Economics.

"Regardless, the continued strength in inflation supports our view that the central bank will tighten policy more aggressively than most expect," he said.

Data shows that household living costs continue to rise, with vegetable prices increasing by 28% year-on-year, rice prices rising by 81.4% and electricity prices rising by 9%.

The data showed that services sector inflation slowed to 1.3% in February from 1.4% in January, indicating that companies are gradually passing on rising labor costs.

At its next policy meeting on April 30-May 1, the central bank will focus on the CPI data to compile new quarterly growth and price forecasts.

The Bank of Japan ended a decade of massive stimulus last year and raised interest rates to 0.5% in January as it believed Japan was close to achieving its inflation target on a sustained basis.

Bank of Japan policymakers have said they are ready to continue raising interest rates if they are confident Japan’s inflation can remain around 2 percent on the back of steady wage increases.