Japan's Inflation Accelerates, But Factory Output Dips, Complicating Rate Hike Outlook

Inflation in Tokyo, Japan's capital, accelerated in December, bolstering expectations for an interest rate hike by the Bank of Japan (BOJ), as reported by Reuters. However, a decline in factory output for November suggests that softening overseas demand could be weighing on the export-reliant Japanese economy.

The Tokyo core consumer price index (CPI), excluding volatile fresh food costs, rose 2.4% year-on-year in December, slightly below the median market forecast of 2.5%. This follows a 2.2% year-on-year increase in November. An index that strips away both fresh food and fuel costs, closely watched by the BOJ, rose 1.8% in December, down from November's 1.9% increase.

Service sector prices, a key indicator of the impact of sustained wage increases on consumer spending, rose 1% in December, following a 0.9% gain in November. "There's a chance higher wages will be passed onto services prices, which is positive for the BOJ in normalising policy," Masato Koike, senior economist at Sompo Institute Plus, told Reuters.

The BOJ is closely monitoring these indicators to assess Japan's progress towards achieving its 2% inflation target, a prerequisite for further rate hikes. The central bank's next policy meeting is scheduled for January 23-24, with some analysts predicting a hike in short-term interest rates.

However, some analysts point to signs of weakness in the Japanese economy and price momentum that could delay the BOJ's rate-hike timeline. The increase in Tokyo inflation was largely driven by higher utility bills and the price of food like rice, factors that could dampen consumption and discourage further price hikes by firms.

Separate data released on Friday revealed that factory output fell 2.3% in November from the previous month, primarily due to a decline in the production of chip equipment and automobiles. This casts doubt on the strength of Japan's fragile economic recovery.

"When stripping away the effect of rising utility bills, there's no sign of strength in inflation," said Toru Suehiro, chief economist at Daiwa Securities, to Reuters. Suehiro believes the BOJ will hold off on raising rates in January.

The BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25% in July, citing steady progress towards its inflation goal. However, the central bank has kept rates steady since then, including at last week's meeting. Governor Kazuo Ueda expressed a preference for more data to gauge next year's wage momentum and for clarity on the incoming US administration's policies before considering further rate hikes.

A Reuters poll published earlier this month indicated that all respondents expected the BOJ to hike interest rates to 0.5% by March 2024. However, the central bank's decision to hold rates steady this month has heightened market uncertainty regarding the timing of a potential hike.