Japan's Core Inflation Rises to 1.6% in June Amid High Oil Prices and Weak Yen

Japan's core inflation came in at 1.6% in June, government data released Friday showed, as the impact of higher oil prices spills over into the wider economy.

This is the first rise in core inflation since March, and was in line with the 1.6% growth expected by economists polled by Reuters. Core inflation in Japan strips out prices of fresh food.

Headline inflation increased to 1.7% from May's 1.5%, while the so-called "core-core" inflation rate, which strips out prices of fresh food and energy, dipped to 1.7%, the lowest since August 2022.

Cushioned by government subsidies, energy prices dipped just 0.1% year-on-year in June, compared with a 2.5% fall in May. Charges for fuel, light and water remained flat, ending 6 straight months of declines.

While Japan has rolled out subsidies to mitigate the impact of the global jump in energy prices for consumers, businesses have seen a sharp rise in costs due to the price spikes, with the producer price index for June hitting 7.1%, highest level since March 2023.

While the inflation figures do not suggest that underlying inflation pressures are strengthening yet due to government measures, upstream price pressures are building, said Norihiro Yamaguchi, lead Japan economist at Oxford Economics, pointing to PPI data.

"We expect core-core CPI inflation to rise again ahead, to around 3% by early 2027," he added.

Japan has been struggling with higher energy prices as the Middle East crisis has hit supplies, while historic weakness in the yen , amplified by elevated oil prices, has further pushed up import costs.

Trade data released Wednesday showed that petroleum imports by the country in terms of value surged by more than 59% year on year, as costs stay elevated. Japan meets over 87% of its energy needs via imports, according to the International Energy Agency.

Weak yen, meanwhile, has raised concerns that Japan will need to deal with higher imported inflation. Yen , which has been trading at multi-decade lows, was flat at 163.82 against the dollar on Friday. The country's benchmark Nikkei 225 stock index was 2.14% lower after the data release.

On Wednesday, Reuters, citing sources familiar with the Bank of Japan's thinking, reported that the central bank "remains on alert to upside inflation risks that could lead to faster interest rate hikes than markets ‌project."

The report said some within the BOJ see a possibility to raise rates faster if price pressures from a weak yen and rising fuel costs from the Iran conflict push ‌up inflation at a faster-than-expected pace.

Yamaguchi said that the BOJ is in a difficult position, as the foreign exchange market continues to call for an earlier rate hike amid concerns that the BOJ might be behind the curve.

However, as the policy rate is approaching the neutral rate levels, the government has become increasingly wary of further rate hikes, he said. Oxford Economics has a neutral rate assumption for the BOJ at 1.5%.

"Our baseline remains a December hike. However, if the recent combination of higher oil prices and a weaker yen proves persistent, an October hike could also come into view."