Influenced by government subsidies, Japan's inflation rate slowed for the first time in four months. However, as the Bank of Japan prepares to announce its latest interest rate decision, this report still underscores the underlying strength of price pressures. Data released on Friday showed that Japan's core Consumer Price Index (CPI), which excludes fresh food, rose 2.4% year-on-year in December, slowing from the 3% increase seen in November, a figure that matched the median forecast from economists. The nationwide headline CPI for December increased by 2.1% year-on-year, down from 2.9% in the previous month and slightly below the expected 2.2%. Last month's subsidy policies had a dual impact. On one hand, gasoline and diesel subsidies introduced in December by the government led by Prime Minister Sanae Takaichi lowered fuel prices; on the other hand, the scheduled cancellation of energy subsidies in December 2024 pushed prices higher, thereby dampening the year-on-year price increase rate for 2025. Energy prices fell 3.1% compared to the same period last year, reversing the 2.5% increase recorded in November. The core inflation index, which excludes energy prices, rose 2.9%, indicating that underlying inflationary pressures remain robust. Shinichiro Kobayashi, Chief Economist at Mitsubishi UFJ Research and Consulting, stated, "The slowdown in inflation is due to policy effects and the conclusion of the price hike cycle. Although the year-end growth rate has slowed, food prices have still risen at a fairly high rate throughout the year, and consumers' perception of inflation remains very strong." In the longer term, the data released on Friday suggests stable price momentum, keeping the Bank of Japan on track for further interest rate hikes. For the full year of 2025, the core inflation rate rose by 3.1%, marking the fourth consecutive year that the CPI increase has exceeded the Bank of Japan's 2% inflation target. The Ministry of Economy said this is the first time since 1992 that this category of CPI has surpassed the target. Analysis points out that the super-core inflation indicator remains around 3%, suggesting that underlying price pressures are still strong, reflecting robust wage growth and a weak yen. In summary, this report should encourage the Bank of Japan to continue its cautious, gradual withdrawal of stimulus measures. The market widely expects the Bank of Japan to keep policy unchanged when it announces its interest rate decision in a few hours, with most economists predicting the next rate hike will occur in June or July. Yen weakness is one factor that could bring forward the timing of the next hike. On Friday morning, the yen traded around 158.45 against the dollar during Tokyo trading, not far from the 160 level. The 160 level is considered the approximate threshold that prompted multiple rounds of intervention by Japanese authorities in 2024. Markets will closely watch Bank of Japan Governor Kazuo Ueda's assessment of price trends during his post-decision press conference, as he must tread carefully in describing the urgency of the next rate hike. If his comments are perceived as dovish, the yen could face renewed selling pressure. Beyond the interest rate decision, the Bank of Japan is also expected to release its latest quarterly economic outlook report. In its October report, the bank indicated that its key inflation gauge—the inflation rate—could slow to below 2% in the first half of fiscal 2026, as the effects of previous price hikes for items like rice gradually fade. Food price increases slowed slightly in December, with processed food price gains easing to 6.7%, while the overall food price index rose 5.1%, down from 6.1% in November. Rice price increases slowed to 34.4% from 37.1% in November. According to a report last month, the number of price hikes by major Japanese food companies from January to April this year is expected to reach about 3,600, approximately 40% fewer than the same period last year. The easing of food inflation will provide some relief for households, which have been strained by rising prices for daily necessities. Public discontent over soaring living costs was a key factor in the ruling Liberal Democratic Party's defeats in two national elections prior to Sanae Takaichi becoming Prime Minister. With Sanae Takaichi having announced a snap election for February 8th, the cost of daily living is set to be a focal point. Recent trends are not encouraging. In November, the proportion of Japanese household total spending allocated to food—the so-called Engel coefficient—reached a high of 28.9%, the highest level for that month since comparable data became available in 2000. Furthermore, a survey released by the Bank of Japan earlier this week showed that Japanese households' long-term inflation expectations remain near historically high levels, with respondents expecting prices to rise by an average of 11.6% over the next year, slightly down from the 11.9% recorded in the previous survey. The weak yen is a key factor, as it raises import costs. Sanae Takaichi has pledged to suspend the 8% tax on food and non-alcoholic beverages for two years if her Liberal Democratic Party wins next month's election. This promise comes on top of the latest round of economic stimulus measures she introduced in December. The government estimates that these measures combined will reduce the average overall inflation rate by 0.7 percentage points from February to April. Recent opinion polls show that Sanae Takaichi's approval rating remains high by historical standards, exceeding 60%, with nearly half of respondents stating that lowering prices is the top priority of her administration. Kobayashi stated, "If yen weakness persists, it could bring forward the timing of the Bank of Japan's next rate hike. However, the policy environment is not that straightforward; the decision cannot be made based solely on inflation trends or the exchange rate. The Bank of Japan also needs to carefully assess the developments in long-term bond yields."