Tokyo inflation exceeds expectations! Bank of Japan issues "overheating alert", rate hike in December is likely?

According to Zhitong Finance APP, as the impact of some temporary measures by the Japanese government fades, Tokyo's key inflation indicator has risen sharply, supporting the Bank of Japan's stance for further rate hikes after authorities accelerated the pace of policy normalization.

Data released by Japan's Ministry of Internal Affairs and Communications on Friday showed that in September, Tokyo's consumer price index excluding fresh food increased by 2.7% year-on-year. This reading is higher than the economists' median forecast of 2.3% and also surpasses last month's 1.8% increase. It marks the first time since January that this indicator has reached or surpassed the 2% level.

The surge in CPI confirms the Bank of Japan's concerns about the upward risks to inflation—these risks could push core price trends beyond its 2% target. After accelerating the pace of normalization last month with its second rate hike in three months—the shortest gap between rate hikes since 1990—the Bank of Japan will be looking for the right timing for the next increase.

The jump in the cost of living occurred even as Prime Minister Sanae Takaichi's energy subsidies continued to drag down the overall index by nearly 0.4 percentage points. Excluding both energy and fresh food, Tokyo's inflation rate—a key indicator of underlying inflation—rose to 3% from 2% a month earlier.

Economist Taro Kimura said, "This report will reinforce the Bank of Japan's view that core inflation is stabilizing near its 2% target—and intensify concerns about rising overshoot risks. We expect the next 25 basis point rate hike in December."

"This is a strong set of data. The impact from child-rearing and water bill reductions is a major factor, but even without these, inflation remains robust," said Yoshiki Shinke, Senior Executive Economist at Dai-ichi Life Research Institute. "The rise in costs triggered by Middle East conflicts is pushing up the cost of living, and unlike the deflationary era, companies are passing on rising costs to consumers."

Shinke said he expects the Bank of Japan to hike rates in December, maintaining the current pace of increases.

Previously, Tokyo's inflation was suppressed by the expansion of child-rearing subsidies and summer water bill reduction policies, prompting broad market expectations for a rebound in inflation. The largest driving factor behind the overall rise was the cost of processed food, which climbed 3.6% year-on-year. According to a report from Teikoku Databank, Japan's major food and beverage companies raised prices on 4,965 products last month, more than double the number a year ago.

Among the factors driving inflation upwards, water bills surged by about 66% year-on-year, while accommodation prices swung from a 1.4% drop last month to a 4.6% increase.

Service prices—a key indicator of demand-driven inflation—rose by 2.3% year-on-year, the biggest jump since November 2023.

The Bank of Japan's quarterly Tankan survey released Thursday shows that large corporations’ business confidence improved for the sixth consecutive quarter. Benefiting from global AI demand combined with a shift in corporate behavior—companies are now passing on rising input costs to end consumers—corporate profits in Q2 hit a record high, marking that inflation expectations are becoming entrenched.

In addition, high oil prices and a weak yen could continue to keep inflation pressures elevated. Despite coordinated exchange rate interventions by the US and Japan in July and repeated warnings, the yen remains near the psychologically significant 160-per-dollar level. Following the data release, the yen slightly appreciated, trading around 158.19 yen per US dollar on Friday.

Earlier this week, the yen had weakened, triggered by the summary of opinions from the Bank of Japan's September monetary policy meeting, which showed that there was no urgency for rate hikes this month. The summary also showed that the Japanese government remains cautious about the Bank of Japan's path for rate hikes. Several cabinet ministers had previously stated their views, leading markets to expect a softer government stance, but the minutes dispelled this speculation.

"The upward price trend may spread further starting from October," said Shotaro Kugo, Senior Economist at the Institute for International Monetary Affairs. "The Bank of Japan expects prices to rise in the second half of the fiscal year, with corporate procurement costs clearly trending upward."