Global Market: BOJ walks tightrope as subsidies mask true inflation trend

Japan’s core consumer inflation fell below the Bank of Japan’s (BOJ) 2% target in February for the first time in nearly four years, as government subsidies on fuel and utilities offset rising import costs driven by a weak yen and elevated oil prices amid geopolitical tensions, according to a news report by Reuters.

Data showed that core inflation, which excludes volatile fresh food prices, rose 1.6% year-on-year in February, easing from 2% in January and coming in slightly below market expectations. This marks the first time since March 2022 that the measure has slipped under the central bank’s target, highlighting the growing impact of government intervention on price trends.

Despite the softer headline reading, underlying inflationary pressures remain relatively firm. A separate index that strips out both fresh food and fuel costs, a metric closely watched by the BOJ to gauge demand-driven inflation, rose 2.5% in February, only marginally lower than the 2.6% increase seen in January, as per the report.


The moderation in overall inflation was largely driven by a sharp decline in energy prices, which fell 9% due to the reinstatement of electricity and gas subsidies. Additional measures, including a gasoline tax cut, also contributed to easing price pressures, shaving nearly a full percentage point off headline inflation. Education costs further pulled inflation down, with tuition fees dropping significantly following expanded government support.

However, outside these policy-driven effects, price pressures remained elevated. Food prices, excluding fresh items, continued to rise at a strong pace, increasing 6% year-on-year, while service-sector inflation held steady at 1%, indicating that domestic demand conditions are still contributing to persistent inflation.

The divergence between headline inflation and underlying trends presents a communication challenge for the BOJ, which has been gradually tightening monetary policy after ending years of ultra-loose settings in 2024. While inflation appears to be easing on the surface, much of the decline is being driven by temporary government measures rather than a fundamental cooling in demand.

To address this issue, the BOJ recently indicated it will introduce a new inflation indicator by the summer that excludes the effects of one-off policy interventions such as subsidies. The move is seen by some analysts as an effort to better capture the true state of inflation and potentially justify further rate hikes.

The central bank remains in a delicate position. On one hand, rising oil prices linked to the Middle East conflict are adding to inflationary pressures. On the other, these same factors are weighing on business sentiment and corporate profitability in an economy heavily dependent on imported energy.

Government efforts to shield households from rising living costs continue to distort price signals. A fresh cap on gasoline prices introduced this month is expected to further suppress inflation, potentially reducing core CPI by up to 0.5 percentage points.

While the BOJ has signaled its readiness to continue raising interest rates if underlying inflation stabilises around its target, the current environment complicates the policy path. The central bank must balance the risk of tightening too quickly against the need to maintain credibility in achieving its inflation goal.

For now, policymakers appear inclined to proceed cautiously, closely monitoring both domestic demand conditions and external risks before making their next move.