(Bloomberg) — Inflation in Tokyo cooled below 2% for the first time in more than a year and a half, a steeper than forecast slowdown that may generate caution at the Bank of Japan over the timing of a widely expected rate hike in the coming months.

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Tokyo consumer prices excluding fresh food rose 1.6% in January, compared with 2.1% growth in December, the ministry of internal affairs said Friday. The figure was the weakest since March 2022 as falls in energy costs deepened and gains in the prices of accommodation and processed food cooled.

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The result, the third consecutive month of easing, compared with a consensus estimate of 1.9% and also showed a slowing of key service prices. Tokyo figures are a leading indicator for the national trend, suggesting that Japan’s overall price growth will also weaken more than previously expected this month. 

The latest figures are likely to complicate the inflation picture for the central bank as it considers the best moment for scrapping the world’s last negative interest rate. While one month’s data from the capital are unlikely to knock it off a widely expected course toward policy normalization, the unexpectedly sharp slowdown may strengthen the case to see more evidence of stable price growth before the first rate hike since 2007 and any further rate hikes.

“I think Ueda has pretty much decided on ending the negative rate and today’s figures don’t change my view that he will make that move in April,” said Toru Suehiro, chief economist at Daiwa Securities. “But he may face the risk of making his call too early. So the BOJ will likely keep its outlook cautious and keep the easing environment intact after ending the negative rate.”

The yen briefly weakened a touch against the dollar to 147.85 from 147.54 immediately before the release as some investors priced a fraction more caution into their views on when the central bank will move. Those moves were largely pared as the morning progressed. The yield on 10-year government debt briefly fell 4 basis points to 0.705% in another indication that market players were recalibrating their views a smidgeon.

Friday’s data showed falls in energy prices deepening to 20% in January to provide the biggest overall drag on the overall price index, while a slowing in gains in processed food to 5.7% took the edge off the biggest upward driver of prices. Lodging costs provided the biggest swing factor in January compared with December, partly a reflection of changes to hotel subsidies a year ago.

A deeper measure of the inflation trend that strips out fresh food and energy prices also decelerated, easing to 3.1%, the fifth month of slowing gains. 

What Bloomberg Economics Says…

“January’s surprisingly big drop in Tokyo inflation is likely to make the Bank of Japan think twice about ending negative rates sooner than later.”

— Taro Kimura, economist

To see the full report, click here

Perhaps of more concern for the BOJ was the softening of service price gains to 1.7% from 2.2% in December. This figure is closely watched by the central bank as a measure of how inflation is spreading through the economy and its nationwide equivalent was repeatedly cited by Governor Kazuo Ueda on Tuesday as he strengthened the case for a near-term end to the BOJ’s negative rate.

The central bank chief’s remarks after this week’s stand-pat decision reinforced the view among economists and investors that the BOJ is gearing up to scrap the rate in March or April. Ueda said that even after a rate hike, monetary settings would remain very supportive of the economy and that the bank would avoid discontinuities in policy. 

Those remarks combined with the latest data suggest the BOJ won’t likely be in a hurry to raise rates again after making its first move, until it has seen more evidence that a positive price cycle has emerged.

The central bank has been watching the progress of annual wage negotiations for signs of a virtuous wage-price cycle that will sustain growth-fueling inflation. The BOJ’s outlook report described that process as gradually intensifying, bolstering the prevailing view among economists that the bank will raise the rate by April after the release of annual wage negotiation results. 

Still, the data from the capital may strengthen the view that the BOJ will bide its time before making any subsequent moves.

“The BOJ will hit the accelerator and the brakes at the same time,” said Suehiro. “Meaning it won’t be raising interest rates further after ending the negative rate.”

(Adds comments from economist)

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