The Bank of Japan is facing a decision today between "clear stability and hidden hawkishness": Japan's December CPI cooled down, but the weak Japanese yen brings potential inflationary pressures.

Affected by government subsidies, Japan's inflation rate has slowed for the first time in four months. However, as the Bank of Japan is about to announce its latest interest rate decision, the report still emphasizes the potential strength of price pressures. Data released on Friday showed that Japan's Consumer Price Index (CPI) excluding fresh food rose by 2.4% year-on-year in December, a slowdown from 3% in November, matching economists' median expectations. The overall CPI growth rate in December fell from 2.9% the previous month to 2.1%, slightly below the expected 2.2%. Last month's subsidy policy had a dual impact. On one hand, the government led by Prime Minister Sanae Takichi introduced gasoline and diesel subsidies in December, which lowered fuel prices; on the other hand, the energy subsidy policy, originally scheduled to be discontinued in December 2024, raised prices, thus dampening the speed of year-on-year price increases in 2025. Energy prices fell by 3.1% compared to the same period last year, reversing the 2.5% increase in November. The core inflation index, excluding the impact of energy prices, rose by 2.9%, indicating that potential inflation pressures remain strong. Chief economist Shinichiro Kobayashi of Mitsubishi UFJ Research and Consulting Co., Ltd. stated, "The slowdown in inflation is due to the policy effects and the end of the price increase cycle. Although the growth rate has slowed at the end of the year, food prices have still risen at a fairly high speed throughout the year, and consumers' perception of inflation remains strong." Looking at the long term, the data released on Friday indicates a stable momentum of price increases, giving the Bank of Japan a chance to further raise interest rates. Core inflation rose by 3.1% in the full year of 2025, marking the fourth consecutive year that the CPI increase has exceeded the Bank of Japan's 2% inflation target. The Japanese Ministry of Economy stated that this is the first time since 1992 that this category of CPI has exceeded the target value. Analysis points out that the super core inflation index remains around 3%, indicating that potential price pressures remain strong, reflecting a softening yen and stable wage growth. In conclusion, this report is expected to prompt the Bank of Japan to continue cautiously gradually withdrawing stimulus measures. It is widely expected in the market that the Bank of Japan will maintain its policy unchanged when announcing the interest rate decision in a few hours, with most economists predicting another rate hike in June or July. The weakening yen is one of the factors that may lead to an early rate hike. On Friday morning, the yen to US dollar exchange rate in the Tokyo trading session was around 158.45, not far from the 160 mark. 160 is considered the approximate critical point for the Bank of Japan's multiple interventions in 2024. The market will closely monitor Bank of Japan Governor Kita Kazuo's assessment of price trends at the press conference after the decision, where he must be cautious in describing the urgency of the next rate hike. If his remarks are deemed dovish, the yen may face new selling pressure. In addition to the interest rate decision, the Bank of Japan is expected to release its latest economic outlook report. In the report released in October, the Bank of Japan stated that with the gradual fading of the impact of previous price increases in rice and other food, its key inflation indicator, the inflation rate, may slow down to below 2% in the first half of the 2026 fiscal year. The price increase in food in December slowed slightly, with the price increase in processed food dropping to 6.7%, while the overall food price index rose by 5.1%, down from 6.1% in November. The price increase in rice slowed from 37.1% in November to 34.4%. According to reports last month, major food companies in Japan are expected to increase prices about 3,600 times from January to April this year, a decrease of about 40% compared to the same period last year. The easing of food inflation will provide some relief for households, as continuously rising prices of daily necessities have made it difficult for families to make ends meet. The dissatisfaction of the people with the soaring cost of living was a key factor in the defeats of the ruling Liberal Democratic Party in the two national elections before Sanae Takichi became Prime Minister. As Sanae Takichi has announced early elections on February 8, the cost of daily living will be a focus of attention. Recent trends are not optimistic. In November, the share of food expenses in total household consumption in Japan, known as the Engel coefficient, reached a high of 28.9%, the highest for that month since comparable data is available since 2000. Furthermore, a survey released earlier this week by the Bank of Japan showed that long-term inflation expectations of Japanese households are still near historic highs, with an average price increase of 11.6% expected for the next year, slightly lower than the 11.9% in the previous survey. The weakening yen is a key factor as it raises import costs. Sanae Takichi has promised that if she leads the Liberal Democratic Party to victory in the upcoming election, she will suspend the 8% tax on food and non-alcoholic beverages for two years. This commitment is based on the latest round of economic stimulus measures she introduced in December last year. The Japanese government estimates that these measures together will reduce the overall inflation rate by an average of 0.7 percentage points from February to April. Recent opinion polls show that Sanae Takichi's approval rating remains high by historical standards, at over 60%, with nearly half of respondents stating that reducing prices is her top priority in governance. Kobayashi stated, "If the yen continues to weaken, it may prompt the Bank of Japan to raise interest rates again sooner. However, the policy environment is not that simple, decisions cannot be made solely based on inflation trends or exchange rates, the Bank of Japan also needs to carefully assess the development of long-term bond yields."