Japanese core inflation data supports May rate hike

The February gain was above the market consensus of 3.5%. Most of the moderation reflected energy subsidy programmes -- utilities costs are down to 6.4% from the previous 11.2% -- and tamer fresh food prices -- down to 18.8% from the previous 21.9%. Yet underlying pressures still appear to be building. Core inflation, excluding fresh food and energy, is more closely watched by the BoJ. It edged up to 2.6% in February, from 2.5% in January. While the rate was in line with market consensus, it marks the fifth straight monthly gain.

On a monthly basis, inflation fell by 0.1% month on month, seasonally adjusted, in February -- the first decline in five months. Goods prices fell by 0.5%, while services rose by 0.1%. We believe lower headline inflation is beneficial for households, indicating an easing of supply-side inflationary pressures. Given the steady rise in service prices, though, a BoJ rate hike could be justified.

With this year's Shunto results likely to result in wage growth well above 5%, inflation and private consumption are worth watching. Today's inflation data shows that services prices continued to rise. The BoJ will want to see how companies pass on input price increases to retail prices. Typically, companies raise prices in the first month of their fiscal year -- April. Therefore, April data is key.

Tokyo's CPI data will be released a few days before the BoJ's April/May policy meeting. The BoJ will decide whether to hike in May or take a "wait and see" approach until June based on next month’s figures. Although Governor Kazuo Ueda made much of the risks surrounding US trade policy on Wednesday, we think he’s just hedging his bets -- considering it a risk factor. Therefore, if trade tensions don't escalate more than the market currently expects, they won't affect the BoJ's rate hike plans.