Slower Tokyo inflation unlikely to deter Bank of Japan’s April hike

Tokyo's consumer price inflation moderated to 1.4% year-on-year in March, below the market consensus of 1.6%. Fresh food (-4.7%) and utility (-6.6%) prices have declined for four consecutive months. They’ve been the primary drivers of declining prices. Meanwhile, transportation costs, including gasoline prices, rose sharply to 2.7% from the previous month’s 1.8%. Core inflation excluding fresh food and energy also eased to 2.3% (vs 2.5% in February), in line with market consensus.

Going forward, we expect a greater impact from rising commodity prices. The government implemented a price cap on gasoline prices in March and began releasing its oil reserves. This will help absorb some price shocks, but monthly growth in fuel and energy prices should accelerate next month. April is typically when businesses adjust prices for the first half of the fiscal year. Thus, we expect a sharper monthly rise starting in April. Yet, due to the base effect, headline inflation is expected to stay below 2% throughout the first half of 2026. Once base effects begin to fade, inflation is expected to rise above 2%. We expect firming inflation to support the BoJ's rate hike in the fourth quarter, or even earlier, depending on developments in the Middle East.

The BoJ introduced new CPI metrics last week that exclude institutional factors. The aim is to give markets a clearer picture of current inflation dynamics. The data showed that the inflation trend, excluding policy impacts (such as free tuition and subsidies on energy, travel and communication fees) moderated, though at a slower pace than the headline suggested and stayed above 2%. We believe that the BoJ signals a rate hike with these new CPI measures. In addition, the March BoJ meeting minutes showed the board moving toward a more hawkish policy amid growing inflation concerns and pushing to reduce monetary easing. Overall, the board voiced concerns that the recent increase in oil prices could increase inflation expectations more than anticipated and may require policy changes soon.

Industrial production dropped -2.1% month-on-month, seasonally-adjusted, in February. This only partially offset the sharp rise (4.3%) in January. We believe this is a technical payback, as manufacturers front-loaded production ahead of the Lunar New Year. Also, some supply constraints for autos have lifted, so production should normalise. In the three-month comparison, IP accelerated relative to the previous quarter. We believe that firm exports and industrial production were supportive of firm 1Q26 GDP growth.

On a separate report, the jobless rate edged down to 2.6% in February (vs 2.7% in January) while job-to-application ratio inched up to 1.19 (vs 1.18 in January). This shows that labour markets remain tight, which should support sustainable wage growth and private consumption.

The outlook remains uncertain amid Middle East conflicts. But the latest data suggest that the economy continued to grow. Also, with an updated potential output gap estimation, it showed that the negative output gap closed with both labour and capital inputs rising. The BoJ expects continued economic recovery, with inflation possibly rising faster than anticipated. Also, encouraging early Shunto negotiation results - with over 5% wage growth - is likely to add to the probability of a 25 bp hike in April.