Japan's July Inflation Surges 3.1% Year-on-Year, Driven by Food Prices

Japan's core inflation rate for July rose by 3.1% year-on-year, significantly exceeding the central bank's 2% target. While this marks a slight decrease from the previous month's 3.3%, it remains well above market expectations of 3.0%. The primary driver behind this inflationary trend is the persistent rise in food prices, particularly rice, which saw a 90.7% year-on-year increase. This surge in food prices has led to a corresponding rise in processed food prices, which increased by 8.3% year-on-year, the fastest pace since September 2023.

Despite the slight easing in core inflation due to a 0.3% year-on-year decrease in energy prices, the overall inflationary pressure in Japan remains robust. The "core of the core" inflation indicator, which excludes fresh food and energy prices, showed a 3.4% year-on-year increase, matching the previous month's figure. This indicator is seen as a more accurate reflection of underlying inflation trends.

The persistent rise in food prices has sparked significant public discontent, particularly with rice, a staple food in Japan. The extreme heatwave has threatened crop yields, raising concerns about potential supply shortages and further price increases. The government has acknowledged the challenges posed by rising food prices and has taken steps to mitigate their impact on consumers.

The inflation data has also fueled expectations of an interest rate hike by the Bank of Japan. Market participants now see a 51% probability of a rate hike by the end of October, up from around 42% a month ago. This shift in expectations is driven by the strong economic growth data released last week, which showed Japan's economy expanding for the fifth consecutive quarter.

Economists have noted that the window for a rate hike is approaching. Capital Economics' senior economist highlighted that the strong economic performance and reduced uncertainty surrounding tariffs suggest that the Bank of Japan should feel confident in normalizing policy soon. The economist also noted that a rate hike in October remains a possibility.

Despite assurances from the Bank of Japan that it is not behind the curve, market participants have expressed concerns about the central bank's delayed response to inflation. The upcoming global central bank meeting, where the Bank of Japan's governor is expected to attend, will be closely watched for any indications of future policy direction.