Japan’s Inflation Cools Down as Energy Prices Drop

Japan’s core consumer prices, which exclude fresh food but include energy costs, slowed down in July as the government’s energy subsidies and lower oil prices eased the inflationary pressure. The core inflation rate was 3.1% in July, down from 3.3% in June, according to the internal affairs ministry. This was in line with the Bank of Japan’s (BOJ) view that inflation has peaked and will gradually decline in the coming months.

BOJ Maintains Stimulative Policy Stance

The BOJ raised its inflation forecast for this fiscal year to 2.5% in its latest outlook report, after inflation proved stickier than expected in recent months. However, the central bank also projected that inflation will fall below 2% in the next two years, indicating that the upward price pressure will weaken as the effects of the pandemic and the consumption tax hike fade away.

Japan’s Inflation Cools Down as Energy Prices Drop
Japan’s Inflation Cools Down as Energy Prices Drop

The BOJ also tweaked its yield curve control policy in July, allowing more flexibility in its bond purchases and widening the range of its target for the 10-year government bond yield. The move was aimed at making its stimulus more sustainable and addressing the side effects of prolonged easing on the financial sector. Governor Haruhiko Kuroda stressed that the policy adjustment was not a step toward normalization, but rather a way to enhance monetary easing.

Food and Service Prices Remain High

Despite the slowdown in overall inflation, some components of the consumer price index remained high in July. Prices excluding energy and fresh food increased 4.3% from a year ago, matching the record high set in May. This was mainly driven by higher food and service prices, which reflected the supply constraints and labor shortages caused by the pandemic.

Food prices rose 4.8% in July, slightly lower than 5% in June, but still well above the historical average of around 1%. Service prices increased 4.1%, unchanged from June, as demand for travel, dining, and entertainment recovered from the state of emergency measures. The government’s Go To Travel campaign, which offered discounts for domestic tourism, also contributed to higher service prices.

Outlook Remains Uncertain

The outlook for Japan’s inflation remains uncertain, as the country faces various risks and challenges. On one hand, the global economic recovery and the progress of vaccinations could boost consumer confidence and spending, leading to higher inflation. On the other hand, the resurgence of COVID-19 cases and the extension of emergency restrictions could dampen economic activity and demand, putting downward pressure on prices.

Moreover, Japan’s inflation expectations are still low and stable, suggesting that consumers and businesses do not anticipate a sustained rise in inflation. According to a BOJ survey conducted in July, households expected inflation to be 2.8% one year ahead and 2.7% five years ahead, while firms expected inflation to be 1.6% one year ahead and 1.7% five years ahead. These figures are below the BOJ’s 2% target and have not changed much over time.

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