Japan's inflation rate has cooled for the second month in a row, which may indicate that the Bank of Japan will wait patiently to raise interest rates because consumption is still weak.

According to data released by Japan's Ministry of Internal Affairs and Communications on Friday, consumer prices (CPI) excluding fresh food rose 2.2% year on year in April, cooling for the second month in a row, in line with analysts' expectations. The index has remained at or above the Bank of Japan's target level of 2% for 25 consecutive months, but policymakers are still keen to see Japan's upward price trend driven by sustainable domestic demand.

The biggest factor dragging down the index was the slowdown in the price increase of processed food products. The increase in this segment slowed to 3.5%, partly due to the base effect. The increase in accommodation costs was also small, which dragged down the overall index.

The inflation target, which excludes fresh food and energy prices, fell to 2.4% in April, which is also in line with general expectations, setting the slowest growth rate since September 2022.

Inflation data is seen as the key for the Bank of Japan to further decide to raise interest rates. The Bank of Japan ended negative interest rates in March of this year, marking a break from the ultra-loose monetary policy it has been implementing for 10 years. The central bank hopes to gradually raise interest rates.

Koya Miyamae, senior economist at Sumitomo Mitsui Nikko Securities, said, “Weak consumption made it difficult for prices to rise in April and May.” He pointed out that the Bank of Japan needs to see core inflation stop cooling before raising interest rates. “I think it's a bit too early to raise interest rates in June and July.”

However, based on the above data alone, the Bank of Japan is unlikely to abandon the opportunity to further reduce its easing policy. Although the Japanese government is suspected of interfering twice in the market to support the yen, the yen remains at its lowest level in 34 years, so Bank of Japan observers are increasingly warning of the risk of early interest rate hikes.

Service prices are a key factor emphasized by the Bank of Japan in policy reviews. The data shows that service prices in Japan rose 1.7% year on year in April, down from 2.1% last month. Economists will pay more attention to this month's data, as April is the beginning of the fiscal year, and many companies will consider implementing price adjustments.

The service price trend in Japan is likely to change in the next few months, as Japan's largest trade union organization has received promises of more than 5% salary increases from large companies. This is the biggest increase in more than 30 years, and many companies will begin implementing wage increases at that time. The Bank of Japan hopes these wage increases will stimulate consumption and prices.

Kohei Okazaki, a senior economist at Nomura Securities, said, “I think that from now on, wage increases will steadily put pressure on price increases, both on the demand side and on the supply side. Our main prediction is that this will happen to some extent.”

Inflation in Tokyo is the leading indicator of national inflation data. After the local government began issuing education subsidies, the city's inflation rate dropped unexpectedly in April. However, analysts, including the NLI Institute, estimate that the impact of these measures on the national index is much smaller, and the negative impact on overall inflation is only about 0.1 percentage points or less.

Additionally, utility subsidies led to a 0.48 percent drop in Japan's overall CPI index. But with the government phasing out these spending starting in May, overall inflation is likely to return to 3% in the summer.

Economist Taro Kimura said, “The Bank of Japan seems to believe that a healthy wage-price cycle will drive future inflation. Expected increases in utility costs will also drive up inflation data in the coming months, providing good prospects for the Bank of Japan to raise interest rates.”

Although consumer spending remains sluggish, Japanese companies increasingly need to weigh whether to raise prices to pass on the rising costs caused by the weakening yen. Household spending has been shrinking for 13 consecutive months as the continued decline in real wages weakens consumers' spending tendencies.

According to a government report this month, the Japanese economy contracted in the first quarter of this year, showing zero or negative growth for three consecutive quarters. A key part of the economic dilemma is personal spending — personal spending in Japan has declined for the fourth consecutive quarter.

Bank of Japan Governor Kazuo Ueda said on Thursday that a poor start to the economy this year will not push the central bank to abandon the path of raising interest rates again because he expects economic growth to rebound. He told reporters before the G7 financial authorities meeting in Stresa, Italy, “So far, there has been no change in the overall recovery situation.”

At the end of last month, the yen fell below 160 against the US dollar. According to Bloomberg's analysis of central bank data, since then, the Ministry of Finance has taken two monetary interventions to support the yen. Authorities have yet to confirm these actions.

There are growing concerns about the depreciation of the yen. According to a report from Teikoku Databank last week, around 64% of companies said the recent depreciation of the yen has eroded their profits. Japan Chamber of Commerce Chairman Ken Kobayashi called on the authorities to take measures to return the exchange rate of yen to around 120-130 against the US dollar.

Economists point out that the depreciation of the yen may cause cost-driven inflation to rise again, posing a new blow to consumption as consumers tighten their budgets.

In this context, Kazuo Ueda recently changed his tone when talking about the foreign exchange market. Earlier this month, after meeting with Japanese Prime Minister Fumio Kishida, he issued a clear warning that rapid exchange rate fluctuations are not desirable.