Headline Japanese inflation eased to 2.0% year on year in December, below expectations (vs 2.7% in November, 2.3% market consensus), mainly due to renewed energy subsidies, stable rice prices, and low petroleum costs. These factors are expected to keep inflation low into 2026, as the government increases winter energy subsidies, oil prices remain weak, and rice prices continue to fall. Thus, headline inflation is expected to drop below 2% in the coming months.
Meanwhile, core inflation, excluding fresh food and energy prices, slowed to 2.6% (vs 2.8% in November, market consensus). Goods prices declined while private services and housing prices showed steady gains in December. Going forward, we expect core inflation to decelerate toward 2%, mainly due to base effects.
With headline inflation expected to drop below 2.0%, and core inflation easing toward 2.0%, the BoJ is likely to carefully assess the impact of previous rate hikes before considering any further hikes. Once the BoJ confirms that core inflation will remain above 2% and outpace headline inflation, it will likely take the next step sometime in the second half of 2026. We believe that strong wage growth and government aid will keep core inflation above 2%. Notably, major labour unions have detailed plans to pursue wage growth of over 5%. Strong corporate earnings are likely to allow for solid wage growth. Also, the government’s shopping voucher and cash payout programmes are expected to stimulate private consumption.
We expect USD/JPY to appreciate modestly in the first half of 2026 as interest rate differentials between the US and Japan narrow. Yet if market concerns shift toward fiscal health — unlike our base-case scenario — and increased direct investment in the US further weakens the JPY, the timing of the BoJ hike could move forward to the second quarter.
AloJapan.com