Japan’s inflation remains elevated, with nationwide CPI hitting 4.0% y/y in January (from 3.6% in December), driven primarily by rising food costs and continued pass-through of transport and labor expenses. Core CPI (excluding perishables) edged up to 3.2% y/y, while the BoJ core CPI (excluding energy and perishables) held firm at 2.5% y/y, underscoring persistent domestic price pressures. Goods inflation contributed +3.38pp to overall inflation, whereas services inflation softened slightly.
Despite these inflationary trends, the BoJ is signalling a gradual policy shift toward normalization. Recent statements from Policy Board members indicate a growing consensus for steady rate hikes, with inflation expected to remain above 2% until mid-2026. The terminal rate forecast has been raised from 0.75% to 1.25%, reflecting prolonged inflationary momentum and potential JPY depreciation risks.
A bit of historical perspective: after decades of struggling with deflation, the country is experiencing its most sustained period of price growth in over 30 years..
The 4.0% print os one of the highest levels over the past two decades, signalling a significant shift from the country's long-standing battle with deflation and low price growth. For much of the past 20 years, Japan’s inflation remained subdued, often struggling to break above 1%, despite repeated monetary interventions. The current inflationary pressures, however, appear to be more persistent and structurally driven, rather than merely the result of external shocks.
Between 2005 and 2012, Japan was entrenched in a deflationary cycle, with annual inflation fluctuating each side of zero. Weak domestic demand, stagnant wages, and a lack of pricing power among firms kept inflation near zero. The GFC deepened these deflationary pressures, with consumer prices contracting by -1.3% in 2009.
A brief departure from this trend came during 2013–2015, when Abenomics sought to reignite inflation through aggressive monetary easing. Inflation temporarily surged to 3.7% in mid-2014, but this spike was largely attributed to a VAT hike (from 5% to 8%) rather than sustained economic growth. As the effects of the tax hike faded, inflation dropped back toward zero.
2016–2019 were defined by continued deflationary pressures despite the BoJ’s historic stimulus measures, including the adoption of Negative Interest Rate Policy (NIRP) in 2016 and Yield Curve Control (YCC) to keep long-term interest rates at ultra-low levels. Even with these efforts, inflation remained weak, averaging between 0.5% and 1.0%, underscoring Japan’s struggle to break free from its deflationary past.
Covid exacerbated this trend, with inflation falling to -0.9% in 2020 as consumer spending collapsed. The BoJ expanded its stimulus programs, but price growth remained sluggish.
Inflation began to take hold in 2022, driven by supply chain disruptions, soaring energy and commodity prices, and the sharp depreciation of the yen. By Dec 22, inflation had reached 4.3%, the highest level since 1981. Throughout 2023/24, inflation remained above the BoJ’s 2% target, marking a major departure from Japan’s long-running deflationary era.
Now we are at 4.0%. While past inflation spikes were often transitory, driven by external shocks or tax hikes, the current trend appears more entrenched. Rising wages, higher labour costs, and the successful passing on price increases to consumers suggest that inflation is becoming more structural rather than cyclical. Barclays now expects core inflation to remain above 2% until at least mid-2026.
The BoJ has acknowledged this shift and the market expects the BoJ’s terminal rate to reach 1.25%, up from a previous estimate of 0.75%.
In the JGB market, investor demand remains robust. January saw net JGB purchases of JPY 5.4tn, holding steady despite rising yields and a reassessment of terminal rate expectations. Notably:
Foreign investors doubled their net JGB purchases to JPY 1.8tn, with strong inflows into the medium-tenor segment.
Trust banks (including pension funds) remained heavy buyers, focusing on medium-term JGBs.
Regional banks and insurers increased allocations, with insurers shifting toward superlong JGBs.
Outlook
Inflation will remain elevated in H1 2025, driven by food and labor cost pass-throughs.
The BoJ is expected to continue rate hikes gradually, but any acceleration depends on external risks, including potential JPY depreciation pressures from U.S. economic policy.
The JGB market remains resilient, with broad-based demand across investor segments, suggesting continued support despite policy normalization.
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