By Megumi Fujikawa

TOKYO--Inflation in Japan's capital cooled below the central bank's 2% target for the first time in over a year, but the slowdown is unlikely to derail further interest rate hikes.

While the headline figure eased, underlying price pressures in Tokyo--considered a leading indicator of nationwide trends--remain firm, with the bulk of the slowdown due to the impact of government subsidies, Friday's data showed.

Excluding fresh food, consumer prices in the Tokyo metropolitan area rose 1.8% in February from a year earlier, compared with the 2.0% increase seen in January. The deceleration was driven largely by a 9.2% plunge in energy prices after the government rolled out subsidies to help households cope with rising living costs.

That marked the first time the Tokyo gauge has fallen below the Bank of Japan's 2% target since October 2024, but the print likely won't shift expectations on monetary policy.

The central bank has been maintaining a cautious but positive stance on further interest-rate hikes following a round of tightening that brought the policy rate to 0.75% in December.

Dai-Ichi Life Research Institute economist Takuya Hoshino said the Tokyo data was "broadly firm," pointing out that service prices, which have a strong correlation with wage growth, rose 1.5%, up slightly from January.

A core measure of inflation which strips out volatile fresh food and energy prices also edged up to 2.5% in February.

While consumer inflation excluding fresh food continued to slow, "the results are unlikely to deter the BOJ from raising interest rates further," he said.

Capital Economics economist Marcel Thieliant agreed, saying that the slew of economic indicators, including inflation figures, released Friday "suggest that the BOJ won't wait much longer before hiking rates again."

Markets are currently pricing in a nearly 60% chance of a rate hike in April, according to data from money market broker Tokyo Tanshi. Traders and BOJ officials are closely monitoring how Prime Minister Sanae Takaichi's planned sales tax cut will affect price trends.

Separate government data on Friday meanwhile signaled that consumption remains solid, with retail sales rising 1.8% in January from a year earlier. Industrial production rose 2.2% on the month in January on the back of front-loaded demand ahead of the Lunar New Year holidays, a sharp reversal from December's 0.1% decrease.

Still, there is continued uncertainty around the outlook for Japanese manufacturers. If weakness in the sector drags on broader economic growth, that could dent the case for rate hikes.

While the U.S. Supreme Court recently struck down so-called reciprocal tariffs, Japanese officials have warned that automobile levies continue to weigh on the industry and said they will continue monitoring the impact of President Trump's new tariffs.

Policymakers say the nation's corporate sector remains resilient despite the headwinds posed by U.S. trade policy, but Friday's data showed factory activity is expected to weaken again in the coming months.

Norinchukin Research Institute economist Takeshi Minami said increasing tensions between Japan and China could weigh on production down the road. Earlier this week, China said that it will ban the export of items that have potential military applications, targeting a list of Japanese companies.

Diplomatic tensions between the two countries have intensified following Takaichi's remarks last year suggesting Japan's potential involvement in any conflict over Taiwan.

Write to Megumi Fujikawa at megumi.fujikawa@wsj.com

(END) Dow Jones Newswires

February 26, 2026 21:44 ET (02:44 GMT)

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