Is the cooling of inflation not changing the resolve to raise interest rates? Japan's January core CPI drops to a two-year low, and central bank communication pressure sharply increases.

The Caixin Finance APP has learned that a key Japanese inflation indicator has fallen to its lowest level in two years, posing communication challenges for the Bank of Japan—despite the cooling data, the central bank is still highly likely to persist with rate hikes when the timing is right. Following the data release, the yen weakened accordingly.

On Friday, Japan’s Ministry of Internal Affairs and Communications announced that the core Consumer Price Index (CPI), excluding fresh food, rose 2.0% year-on-year in January, the smallest increase since January 2024, aligning with economists’ median expectations; the previous reading was a 2.4% increase.

Meanwhile, the index excluding fresh food and energy, which better reflects underlying inflation pressures, rose 2.6% year-on-year, still well above the Bank of Japan’s 2% inflation target. The overall inflation rate, including all items, fell to 1.5%, dropping below 2% for the first time since March 2022.

The Friday data shows that Japan’s price increases have slowed compared to last year, partly due to fiscal measures introduced by Prime Minister Fumio Kishida to ease living costs. In 2025, Japan’s inflation rate excluding fresh food surged to 3.1%, remaining above 2% for the fourth consecutive year.

This slowdown in inflation is mainly driven by temporary factors and food prices. In January, the government reduced fuel costs through tax cuts and other measures, leading to a 5.2% year-on-year decline in overall energy prices; at the same time, due to high base effects from the same period last year, the increase in food prices excluding fresh food also narrowed.

Taro Saito, Director of Economic Research at NLI Research Institute, said, “The weakening of food inflation and the decline in gasoline prices are the two main reasons for this slowdown. As government utility subsidy policies take effect, the core CPI is almost certain to fall below 2% in the next data release.”

Following the data, the yen briefly fell from around 154.98 to about 155.20 against the US dollar. As of press time, the exchange rate hovered around 155.05.

The Bank of Japan had previously warned that, influenced by government utility subsidies and high base effects from last year’s same period, price increases would slow down. Authorities emphasized that they are more focused on underlying inflation levels than one-off factors.

Therefore, this data is unlikely to shake the Bank of Japan’s policy resolve— as long as conditions permit, the central bank will continue normalizing policy through rate hikes. Most economists believe the bank may act as early as April, with a lower likelihood of adjusting rates at the March 19 policy meeting.

Saito commented, “I don’t think today’s data will change the BOJ’s stance on rate hikes, but raising rates amid slowing inflation data means the bank needs to communicate more cautiously.”

In its quarterly outlook report last month, the Bank of Japan indicated that core inflation is likely to fall below 2% in the first half of this year. Even with this assessment, due to companies continuing to pass on rising costs to consumers, the bank raised its inflation expectations, exceeding market forecasts.

Economist Taro Kimura said, “The cooling of inflation, combined with Prime Minister Fumio Kishida’s strong victory in the early election and the implicit pressure to maintain easing, means the BOJ does not need to rush. We expect rising labor costs to continue transmitting to prices, prompting the bank to hike rates in July.”

As a key indicator of inflation persistence, service sector prices rose 1.4% year-on-year in January, unchanged from the previous month. Rice prices, which were a major driver of inflation last year, increased by 27.9% year-on-year, continuing to cool after reaching a record 101.7% increase in May last year. Food prices excluding fresh food rose 6.2%, the slowest pace since March last year.

High food prices have become a political focal point in Japan. Especially before Prime Minister Fumio Kishida took office in October last year, surging living costs led to two major defeats for the ruling Liberal Democratic Party in elections.

Last year, Japanese household food expenditure reached its highest level in 44 years. To address this, Prime Minister Kishida, after winning the recent general election, reiterated plans to suspend the food consumption tax for two years.

The effects of the utility subsidy measures introduced by Kishida are expected to further manifest in upcoming data, continuing to suppress inflation. SMBC Nikko Securities forecasts that the core inflation rate excluding fresh food in February will slow to around 1.6%.

Japanese authorities are closely monitoring whether the cooling inflation can ultimately lead to wage increases surpassing price rises, reversing the trend of declining real wages for several months last year. In theory, this would boost consumption and make inflation more sustainable.

In the fourth quarter of 2025, Japan’s economy grew by 0.1% quarter-on-quarter, with private consumption increasing by only 0.1%, significantly below market expectations.

Saito stated, “I believe underlying inflation is weakening. Companies have already passed on costs significantly, and their willingness to raise prices has diminished. Additionally, the yen’s lack of sustained depreciation has also helped ease inflation.”