Japan's Inflation Unexpectedly Falls to Near Four-Year Low, But Subsidy Withdrawal + Soaring Oil Prices May Make 'Cooling' Short-Lived

Bloomberg News has learned that Japan’s key inflation indicator slowed more than expected, dropping to its lowest level in nearly four years, mainly due to utility subsidies lowering energy costs. However, recent surges in oil prices could push inflation back up in the coming months.

Japan’s Ministry of Internal Affairs and Communications released data on Tuesday showing that the consumer price index (CPI), excluding fresh food, rose 1.6% year-on-year in February, the smallest increase since March 2022. The figure was below economists’ median forecast of 1.7%, with the previous reading at 2%. Core inflation, which excludes energy to reflect underlying inflationary pressures, increased 2.5%, well above the Bank of Japan’s 2% target. Overall inflation, including all categories, fell to 1.3%, the lowest since March 2022.

Energy prices fell by 9.1%, mainly driven by declines in electricity prices. Food prices excluding fresh food slowed from a 6.2% increase in January to 5.7% in February. Service prices— a key indicator of underlying inflation—continued to rise 1.4% year-on-year. Rice prices, which surged last year, increased 17.1% in February, continuing to decline from the record 101.7% increase in May 2025.

Taro Saito, Chief Economist at the Japan Research Institute, said, “The main factor behind the slowdown in inflation is government utility subsidies. However, due to the impact of the Iran conflict, core CPI is likely to rebound to around 2% in the next data release, overturning market expectations that inflation would stay below 2% for some time before the war.”

Despite signs of easing inflation, consumers are facing pressure from soaring gasoline prices, which could prolong more than four years of squeezed living costs. Japan’s heavy reliance on imported energy makes it one of the economies most vulnerable to escalating tensions in the Middle East.

Economist Taro Kimura said, “Core inflation excluding subsidy effects remains well above the 2% target, indicating that the wage-price cycle remains healthy and could be reinforced by recent wage negotiations. This also keeps the Bank of Japan cautious about how supply shocks transmit to potential price trends, prompting it to consider raising interest rates in the short term.”

Following the data release, the yen weakened, falling from around 158.35 to 158.56 against the dollar. The yen has been hovering near the 160 level, a threshold that has previously prompted government intervention multiple times in 2024. A weaker yen increases import costs, adding to inflationary pressures.

Oil prices remained high on Monday, about 50% above levels before the outbreak of the Iraq war last month. As a result, Japan’s gasoline prices surged to their highest levels since 1990 last week.

In this context, Bank of Japan Governor Kazuo Ueda hinted last Thursday that a rate hike in April is not out of the question, citing the need to monitor both upside and downside risks to prices. The overnight index swap market prices in about a 63% chance of a rate increase.

Economists generally expect February’s inflation to slow, as Prime Minister Fumio Kishida resumed a three-month utility subsidy program in January. The effects of these measures began to show in Tuesday’s data. Last week, the government also reinstated gasoline subsidies aimed at capping prices at 170 yen per liter, after prices had already risen to a record 190.8 yen per liter.

With Japan carrying the world’s heaviest public debt burden, investors are closely watching how long Prime Minister Kishida will maintain energy subsidies and what additional measures might be introduced. The prime minister’s recent victory in an overwhelming election was partly attributed to his pledge to address the cost-of-living crisis through fiscal measures.

JPMorgan analysts wrote in a report last week that if crude oil prices stay around $100 per barrel through the end of April, the inflation-suppressing effects of government measures might only be temporary, and Japan’s core inflation excluding fresh food could accelerate to about 2.5% by May.

Taro Saito said, “The CPI trend also depends on government responses. Unless the government takes action, as long as conflicts continue, living costs will keep rising.”