Japan faces new inflation pressures.

The Pai Mall BarterGovernor of the Bank of Japan, Kazuo Ueda, issued a warning at a high-level meeting on May 27th, stating that the surge in food prices is becoming a "hidden bomb" driving up core inflation and may prompt the central bank to reassess its monetary policy path. This warning is particularly striking against the backdrop of decades of low inflation or even deflation in Japan.

Data shows that Japan's current core inflation rate is nearing the central bank's set target of 2%, with prices of staple foods like rice rising nearly 90% year-on-year, far exceeding market expectations. Ueda pointed out that "table inflation" has broken the traditional inflation logic driven by economic recovery and labor shortages, suggesting that the central bank is facing a critical point for policy adjustment.

Although the Bank of Japan maintains an official stance that price increases will "gradually weaken," Ueda admitted: "When core inflation stands at the 2% threshold, any disturbance could trigger a chain reaction." This remark reveals the deep concerns at the Bank of Japan about the potential risks of "inflation expectations becoming unanchored."

Two Worlds: Soaring Inflation vs. Economic Slowdown

The Bank of Japan currently faces a dilemma in policy making. April's core inflation rate has risen to 3.5%, marking a two-year high, with food price increases reaching 7%. Meanwhile, factors like U.S. tariff hikes and weakening external demand are casting shadows over Japan's economic growth prospects, forcing the central bank to lower its growth expectations.

In January, the Bank of Japan made a slight interest rate increase, raising the short-term rate to 0.5%, signaling a move away from zero interest rate policies. However, recent surveys show that most economists believe the Bank of Japan will maintain its current stance until at least September, with only a few predicting another rate hike by the end of the year. In response, Ueda stated that future policies will be evaluated monthly with high caution, akin to dismantling precision instruments.

Inflation Endurance Test: The Pace of Rate Hikes is Key

The pressure behind inflation is not only reflected in price data but also tests the resilience of Japan's economic structure. Last year, the Bank of Japan ended its decade-long ultra-loose monetary policy, marking the end of the "Abenomics" phase. The current challenge is how to control inflation without stifling the nascent economic momentum.

The central bank's forecast indicates that core inflation is expected to stabilize around 2% by the second half of fiscal year 2027. However, Ueda warned of high uncertainty, particularly if prices of essential commodities like rice continue to spiral out of control, which could severely impact consumer confidence and possibly force the central bank to initiate an earlier rate hiking cycle.

Market Impact: Yen's Trajectory Under Watch

Amid rising inflation, the market's judgment about Japan's rate hike prospects is subtly shifting. In the short term, rising inflation could lead to a moderate strengthening of the yen, especially with expectations of a weakening dollar or an interest rate cut path by the Federal Reserve. However, given that Japan's economy still faces issues like weak external demand and low domestic business confidence, the central bank may not rapidly advance rate hikes.

In the coming months, investors should closely monitor three key variables: first, whether Japan's wage growth and inflation continue to exceed expectations; second, the pace of adjustments in Federal Reserve policy; and third, whether the Japanese government will intervene in the forex market to curb yen depreciation risks.

At 10:49 a.m. Tokyo time, the dollar-yen exchange rate stood at 142.34/35, with the market continuing to watch for the next policy signals from the Bank of Japan.

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