Core inflation likely above target
Japan's battle with inflation has entered a new phase. Core consumer inflation in September likely exceeded the Bank of Japan's 2 per cent target for the first time since December, according to a Reuters poll of economists published on 16 October. The nationwide core consumer price index, which includes energy items but excludes fresh food prices, is expected to have risen 2.1 per cent in September from a year earlier, accelerating from 1.7 per cent in August. At the same time, Bank of Japan Governor Kazuo Ueda warned that underlying inflation could overshoot the central bank's target, stressing the growing importance of keeping price pressures anchored around 2 per cent. Together, the data and the warning have fuelled market expectations that the Bank of Japan could raise interest rates again in the coming months.
Japan's deflation history
To understand why this matters, it helps to recall Japan's unusual economic history. For more than two decades, Japan struggled with deflation, a persistent fall in prices that discouraged spending and investment. When prices are expected to fall, consumers delay purchases, businesses postpone investment, and wages stagnate. The Bank of Japan spent years trying to generate modest inflation, using ultra-low interest rates, massive asset purchases, and negative interest rates. For much of that period, it failed. The 2 per cent inflation target, adopted in 2013, was for years an aspiration rather than a reality. The fact that Japan now faces the opposite problem, inflation that may be too high rather than too low, marks a profound shift in the country's economic landscape.
The 23 October data release
The September inflation data, which the internal affairs ministry is scheduled to release on 23 October, will provide the official confirmation. The Reuters poll of 15 economists put the expected core CPI rise at 2.1 per cent. The acceleration from 1.7 per cent in August was driven in part by higher energy prices, as the conflict in the Middle East fed through to household fuel and electricity costs. Food prices, excluding rice, and daily necessities were also expected to show faster growth, according to market economist Ryosuke Katagi of Mizuho Securities, who cited the deteriorating situation in Iran as a factor. Separate data released earlier in the week showed that Japan's wholesale inflation rose 6.8 per cent year-on-year in September, slowing from the previous month but still underscoring persistent price pressures in the supply chain that eventually reach consumers.
Governor Ueda's remarks
Governor Ueda's remarks added weight to the data. In a speech read out by Deputy Governor Shinichi Uchida at a meeting of Japanese credit unions, Ueda said that factors including tensions in the Middle East, AI-related demand and currency swings could affect Japan's economy and prices, pointing to a risk that underlying inflation could exceed the Bank of Japan's price target. He said that the perspective of anchoring underlying inflation at around 2 per cent had become more important than before, highlighting the need to ensure that any overshoot of the target does not harm the economy. The speech largely repeated remarks Ueda had made earlier in October, but its timing, just ahead of the Bank's 29-30 October policy meeting, gave it added significance. The Bank will release fresh quarterly growth and inflation forecasts at that meeting, which market participants will scrutinise for clues on the timing of the next rate hike.
The Bank of Japan's moves
The Bank of Japan has already moved decisively. It raised its key rate to a 31-year high last month, having also hiked in June, and signalled that it had entered a phase focused on preventing underlying inflation from overshooting its target. At 1.25 per cent, the policy rate remains low by global standards, and real borrowing costs are still negative with inflation around 2 per cent, meaning that monetary policy is still accommodative. But the direction of travel is clear: the Bank has pivoted from fighting deflation to containing inflation. Bank of Japan board member Junko Koeda said on 15 October that the central bank should not become overly cautious about raising interest rates given considerable upside risks to inflation, signalling the chance of a near-term hike. The Bank may signal this month that underlying inflation has roughly hit its 2 per cent target, highlighting its readiness to raise rates again in the coming months, although many inside the central bank are wary of hiking again at the October meeting itself.
International pressure and the yen
International pressure is also building. US Treasury Undersecretary Erin Browne said on 16 October, in Bangkok for the annual meetings of the International Monetary Fund and World Bank, that Japan no longer faces the deflationary environment that existed for more than a decade, and that the level of its currency and monetary policy must change accordingly. She warned that sharp, disorderly currency moves can create wider consequences, forcing investors to unwind positions, creating volatility across markets, and potentially raising financing costs in both the United States and globally. The yen has weakened as the gap between US and Japanese interest rates has remained wide, increasing import costs for Japan. The US Federal Reserve's rate decision at its 27-28 October meeting could affect the Bank of Japan's debate through its impact on the yen. The IMF, at its annual meetings, highlighted the resilience of the global economy against external shocks such as the Middle East war, with the pain mitigated by brisk AI-related demand, but also warned of inflationary pressure from the AI boom that could warrant further monetary tightening, a message particularly relevant to the Bank of Japan given its still-low borrowing costs.
What it means for households
For ordinary Japanese households, the return of inflation is a mixed experience. On one hand, it reflects a healthier economy in which wages are finally rising after years of stagnation. Many Japanese companies have agreed to significant wage increases in recent years, and a tight labour market has given workers more bargaining power. On the other hand, higher prices for energy, food and daily necessities squeeze household budgets, particularly for retirees and low-income families. The Bank of Japan's challenge is to raise rates enough to prevent inflation from becoming entrenched, without raising them so much that it chokes off growth or destabilises financial markets. That balancing act is familiar to central banks everywhere, but it is new for Japan, which spent so long trying to create inflation that it has little recent experience in containing it.
What happens next
What happens next will depend on the data. The official September CPI release on 23 October will confirm whether core inflation has indeed moved above 2 per cent. The Bank of Japan's 29-30 October meeting will reveal its new forecasts and its assessment of the risks. If the Bank signals that underlying inflation has roughly hit its target, markets will price in a higher probability of a rate hike at a subsequent meeting, possibly before the end of the year. If the Bank urges caution, the hike may be delayed. Either way, the era of ultra-loose Japanese monetary policy is ending, and the world's third-largest economy is adjusting to a new reality in which inflation, interest rates and the yen behave more like those of other advanced economies. For global investors, that shift matters: Japan's low rates long made the yen a funding currency for carry trades, and a sustained rise in Japanese rates could reshape capital flows far beyond Tokyo.
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