Inflation surge in Japan strongly justified BoJ's rate hike

The Jan. 24 interest-rate hike in Japan was widely anticipated. But the inflation data released the same day strongly justified the Bank of Japan’s (BoJ) decision to raise the deposit rate to 0.5%, the highest level since the global financial crisis.

Headline inflation surged to a 3.7% year-on-year pace in December – the steepest increase since early 2023, when global supply chain disruptions were still sending consumer prices soaring around the world.

Japan's core inflation also rose (though not as sharply as the headline figure), increasing from 2.7% to 3% y/y. This suggests that much of the jump was driven by volatile food and energy prices.

Inflation in Japan has remained above the central bank's 2% target for more than three years. While much of these price pressures were due to Japan's dependence on imported goods, BoJ Governor Kazuo Ueda is now more confident that Japan’s internal price dynamics are on track to sustainably meet the 2% target, bolstered by forecasts of higher wage growth.

Unlike the surprise rate hike in July, this move was clearly signaled in advance – allowing markets to adjust. The yen began appreciating about two weeks ahead of the BoJ’s meeting.

According to the FocusEconomics consensus forecast, the yen is expected to continue strengthening. The USD/JPY exchange rate is projected to appreciate to 140 by then, down from about 160 yen per dollar currently. Meanwhile, the central bank's key rate could reach 1% by the end of 2026.

A stronger yen, however, could pose challenges for Japanese exporters, who typically benefit from a weaker currency. Since August 2024, export growth has slowed to single digits; it even turned negative in September. CEIC’s nowcast accurately predicted a further deceleration in December – and growth is expected to remain below a 4% year-on-year pace for January.

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