Japan's key inflation gauge fell to its lowest level in two years, posing a communication challenge for the Bank of Japan as it is expected to maintain its commitment to raising interest rates when conditions permit, despite the cooling data. Following the release, the yen weakened.
Data from the Ministry of Internal Affairs and Communications showed on Friday that core CPI, which excludes fresh food, rose 2.0% year-on-year in January. This marked the smallest increase since January 2024, matching the median economist forecast, and was down from a 2.4% rise previously. Meanwhile, a key indicator excluding both fresh food and energy, which better reflects underlying inflation trends, increased 2.6% year-on-year, remaining well above the central bank's 2% inflation target. The headline inflation rate, which includes all items, fell to 1.5%, dropping below the 2% level for the first time since March 2022.
Friday's data indicated that price growth in Japan has slowed compared to last year, partly due to fiscal measures introduced by Prime Minister Takaichi Sanae to ease cost-of-living pressures. In 2025, Japan's inflation rate excluding fresh food had surged to 3.1%, exceeding the 2% target for the fourth consecutive year. The recent slowdown was primarily driven by temporary factors and food prices. In January, government measures such as tax cuts helped reduce fuel costs, leading to a 5.2% year-on-year decline in overall energy prices. Additionally, food prices excluding fresh items saw a narrower increase due to a high base effect from the same period last year.
Taro Saito, Chief Economist at NLI Research Institute, stated, "Weaker food inflation and lower gasoline prices were the two main reasons for this slowdown. With the effect of government utility subsidies becoming apparent, core CPI is almost certain to fall below 2% in the next data release." Following the data announcement, the yen weakened against the U.S. dollar, moving from around 154.98 to approximately 155.20. As of the latest update, the exchange rate hovered near 155.05.
The Bank of Japan had previously warned that price growth would moderate due to factors including government utility subsidies and the high base effect from the previous year. Authorities emphasized that they are more focused on underlying inflation trends than one-off factors. Consequently, this data is not expected to动摇 the central bank's policy determination—it is likely to continue progressing with policy normalization via interest rate hikes as long as conditions allow. Most economists believe the central bank could act as soon as April, with a relatively smaller chance of an adjustment at the next policy meeting on March 19.
Saito commented, "I don't think today's data will change the BOJ's stance on raising rates, but hiking against a backdrop of slowing inflation data means the bank will need to communicate more carefully." In its quarterly outlook report last month, the BOJ stated that core inflation will likely fall below 2% in the first half of this year. Despite this assessment, the bank raised its inflation forecasts by more than market expectations, citing that companies continue to pass on cost increases to consumers.
Economist Taro Kimura said, "Cooling inflation, coupled with implicit pressure for continued easing following Takaichi Sanae's decisive election victory, suggests the BOJ is under no urgent pressure to act. We expect rising labor costs to continue feeding into prices, prompting a rate hike in July." A key gauge of inflation persistence, services prices, rose 1.4% year-on-year in January, unchanged from the previous month. Rice prices, a major driver of inflation last year, increased 27.9% year-on-year, continuing to cool after hitting a record 101.7% rise last May. Food prices excluding fresh items rose 6.2%, the slowest pace since March of last year.
High food prices have become a focal point in Japanese politics. Soaring living costs, particularly before Takaichi Sanae became Prime Minister in October, contributed to significant election losses for the ruling Liberal Democratic Party. Last year, the share of household spending on food reached its highest level in 44 years. Addressing this issue, Takaichi Sanae reiterated after leading the LDP to election victory this month that a two-year suspension of the consumption tax on food would be implemented. The effects of utility subsidies introduced by Takaichi Sanae are expected to become more visible in subsequent data, continuing to suppress inflation. SMBC Nikko Securities forecasts that core inflation excluding fresh food will slow to around 1.6% in February.
Japanese authorities are closely monitoring whether cooling inflation will finally allow wage growth to outpace price increases, reversing the trend of declining real wages for many months last year. In theory, this would boost consumption and make inflation more sustainable. In the fourth quarter of 2025, Japan's economy grew 0.1% quarter-on-quarter, with private consumption also rising a mere 0.1%, significantly below market expectations.
Saito concluded, "I believe underlying inflation is weakening. Companies have already largely passed on costs, and their willingness to raise prices now has diminished. Furthermore, the absence of sustained yen depreciation has also helped ease inflation pressures."