Japan's Core Inflation Hits 3.7% Year-on-Year in May

Japan's core inflation rate surged to 3.7% year-on-year in May, marking the highest level since early 2023 and exceeding forecasts of 3.6%. This increase from April's 3.5% indicates that inflation has remained above the Bank of Japan's (BOJ) 2% target for over three consecutive years. The persistent rise in prices is driven by essential food items, with prices for staples like rice doubling since May 2024. A rice ball now costs nearly 20% more, and a simple bar of chocolate has increased by 27%.

Inflation in services, such as restaurants, haircuts, and healthcare, also rose to 1.4% from April's 1.3%, indicating that businesses are gradually transferring their labor costs to consumers. The BOJ faces a complex situation as it ended its massive stimulus program last year and raised short-term rates to 0.5% in January, believing Japan was close to sustainably hitting the 2% inflation target. However, global risks, including renewed tariff threats from the U.S. under Donald Trump, have resurfaced, making Japan's export-dependent economy vulnerable again. This uncertainty has led the BOJ to adopt a cautious approach, delaying further rate hikes for now.

Ryosuke Katagi, a market economist, noted that the BOJ is being cautious due to heightened uncertainty over U.S. tariff policy. He expects conditions for additional rate hikes to remain in place throughout 2025. This view is supported by another inflation measure, which excludes fuel and fresh food, and climbed 3.3% in May compared to 3.0% in April. This is the fastest increase since January 2024, when it hit 3.5%. The BOJ closely monitors this specific number to gauge whether inflation is driven by strong demand or external costs.

In Tokyo, analysts expect core inflation to slow to 3.3% in June, down from 3.6% in May. Tokyo's numbers often serve as early indicators for the entire country, but the drop is not significant enough to reassure the central bank, especially with non-fresh food prices up 7.7% from a year earlier, higher than April's 7.0%. Inside the central bank, there is a growing debate. Minutes from the BOJ’s April 30–May 1 meeting revealed a divided board, with some members concerned that inflation will continue to rise beyond projections. The possibility of a wage-price spiral is also being seriously considered.

A research paper published by the bank suggested that raising rates slowly, while raw materials remain expensive, could trigger an upward loop between wages and consumer prices. Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute, noted that inflation is exceeding expectations, particularly in food costs, which are re-accelerating this year. He expects core inflation to fall below 3% in August and possibly under 2% by early 2026, but warned that the slowdown might be weaker than anticipated. The BOJ still maintains that cost-push pressure will ease later this year, and with expected wage growth, they hope to see more domestic consumption. This logic is being used to avoid another hike for now, as they aim for inflation to hit 2% due to demand, not just because of out-of-control food prices.

However, patience is waning. A poll of economists found that a slight majority expect the next 25-basis-point rate hike to occur in early 2026. But with the latest CPI report, this timeline could be accelerated, especially if inflation continues to rise and Trump's tariff agenda starts to impact exports more significantly. The situation remains fluid, with the BOJ balancing the need to control inflation against the risks posed by global economic uncertainties.