Inflation in Tokyo reaches highest point in 2 years

Key takeaways

Core inflation in Tokyo rose to its highest level in two years in April, driven mainly by rising food prices.The Bank of Japan faces a major challenge in striking the delicate balance between maintaining its ultra-loose monetary policy and addressing rising prices against the backdrop of possible U.S. import duties.Despite persistent inflationary pressures, the Bank of Japan may become more cautious about future rate hikes because of downside risks to growth and prices.

Core inflation in Tokyo rose to its highest level in two years in April, mainly due to rising food prices. This poses a major challenge for the Bank of Japan (BOJ), which must strike a delicate balance between maintaining its ultra-low monetary policy and addressing rising prices against the backdrop of possible U.S. import duties.

Tokyo’s consumer price index, excluding volatile fresh food prices, rose 3.4 percent year-on-year in April. This exceeded market expectations and marked the highest level since April 2021. This acceleration follows a 2.4 percent increase in March.

Bank of Japan decision-making process

Although Kazuo Ueda, governor of the BOJ, has indicated his intention to continue raising interest rates, the potential impact of U.S. rates complicates the central bank’s decision-making process on the timing and size of future rate hikes.

Sources suggest the BOJ will downgrade its economic growth forecasts and emphasize the escalating risks due to U.S. tariffs, which are expected to negatively impact global demand.

Reasons behind inflation

The sharp rise in inflation in April resulted from a cut in government subsidies to reduce electricity and gas bills, along with a series of food price increases implemented on April 1, the start of Japan’s new fiscal year. In addition, the introduction of education subsidies in Tokyo a year ago had already dampened inflation rates.

A separate index, which excludes the cost of both fresh food and fuel and is closely watched by the BOJ as a broader indicator of price trends, rose 3.1 percent year on year in April after a 2.2 percent increase in March.

Future interest rate hikes

Despite continued inflationary pressures, the path forward for the BOJ may become more complicated. Overall upward inflationary momentum suggests that the central bank is likely to continue phasing out its decades-long easy monetary policy framework.

Following the termination of its radical stimulus program last year and an interest rate hike to 0.5 percent in January, the BOJ believes Japan has almost sustainably reached its inflation target of 2 percent.

Government response

Economists at HSBC predict the BOJ will take a cautious approach to further rate hikes, citing downside risks to growth and prices as potential deterrents to reaching a policy rate of 1.0 percent by the end of 2026. According to a Reuters poll, the next interest rate increase of a quarter percentage point will occur in the third quarter.

In an effort to mitigate the impact of tariffs, the Japanese government on Friday announced an emergency economic package, including the reintroduction of subsidies to reduce electricity bills. Mizuho Securities estimates that such subsidies could reduce core consumer prices by up to 0.4 percentage points.

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