Japan's core inflation hit a more than two-year high in May and exceeded the central bank's 2% target for well over three years, keeping it under pressure to resume interest rate hikes despite economic headwinds from U.S. tariffs.
The data underscores the challenge the Bank of Japan faces in juggling pressure from sticky food inflation and risks to the fragile economy from uncertainty over President Donald Trump's trade policy.
The core consumer price index (CPI), which excludes volatile fresh food costs, rose 3.7% in May from a year earlier, data showed on Friday, exceeding market forecasts for a 3.6% gain and accelerating from a 3.5% increase in April.
The rise, which was the fastest annual pace since the 4.2% hit in January 2023, was driven largely by stubbornly high prices of food - particularly those of Japan's staple rice that saw prices double in May from year-before levels.
While slower than the 5.3% increase in goods prices, service-sector inflation accelerated to 1.4% in May from 1.3% in April in a sign firms were steadily passing on labour costs.
"Given heightened uncertainty over U.S. tariff policy, the BOJ is taking a wait-and-see approach to scrutinise developments in bilateral trade talks," said Ryosuke Katagi, market economist at Mizuho Securities.
"But today's data shows anew that domestic inflation is heightening particularly that for goods. When looking just at price moves, conditions for additional rate hikes will likely stay in place throughout 2025," he said.
A separate index that strips away the effects of both volatile fresh food and fuel costs rose 3.3% in May from a year earlier after a 3.0% rise in April, the data showed.
The rise in the index, which is closely watched by the BOJ as a better indicator of demand-driven price moves, was the fastest since January 2024 when it increased 3.5%.
Food prices, excluding those of volatile fresh food, rose 7.7% in May from a year earlier, faster than the 7.0% gain in April, reflecting the pain households are feeling from rising living costs.
BOJ policymakers expect such cost-push pressures to moderate later this year and, coupled with expected rises in wages, underpin consumption and keep Japan on track to durably achieve their 2% inflation target backed by solid domestic demand.
Takeshi Minami, chief economist at Norinchukin Research Institute, expects inflation to slow in the latter half of this year and fall below 2% early 2026 as food price rises moderate.
Government subsidies to curb gasoline costs will also likely mitigate upward price pressure from any spike in oil costs caused by the escalating Middle East conflict, he added.
"The BOJ will enter a period where it weighs the hit to exports from Trump tariffs and the impact intensifying domestic labour shortages could have on wages," Minami said.
The BOJ ended a massive stimulus programme last year and in January raised short-term rates to 0.5% on the view Japan was on the cusp of durably meeting its 2% inflation target.
While the central bank has signalled readiness to raise rates further, the repercussions from higher U.S. tariffs forced it to cut its growth forecasts and complicated decisions around the timing of the next rate increase.
A slight majority of economists in a Reuters poll expected the BOJ's next 25-basis-point increase to come in early 2026.
