By Kosaku Narioka and Fabiana Negrin Ochoa
Japan's consumer prices rose at a slower pace in February, but the inflationary risks posed by the war in the Middle East loom large, likely keeping the central bank on its toes.
A pullback inflation can buy the central bank time to thoroughly examine the economic threat posed by the conflict and the surge in energy prices--a major issue for Japan, as it relies heavily on imports from the Middle East. But government subsidies played a big part in last month's inflation print, and analysts say the relief could be fleeting.
Data on Tuesday showed that consumer inflation, excluding volatile fresh food prices, climbed 1.6% from a year earlier. That compared with January's 2.0% and the 1.7% rise expected in a poll by data provider Quick.
The result marked the first time since March 2022 that the core measure fell below the Bank of Japan's 2% inflation target.
Still, economists say the cooldown looks temporary, and with the Middle East muddying the outlook, the case for more rate hikes is firm.
Japan's inflationary pressures are more entrenched than February's headline result suggests, according to Capital Economics' Abhijit Surya. Generous electricity and gas subsidies that lapse in April artificially subdued the reading, keeping a lid on energy, said the senior economist in a note.
Inflation did cool across most other categories, too, adding to a trend over recent months showing that the cost-push forces that initially lifted prices have eased, for now, said Stefan Angrick at Moody's Analytics.
"But with the conflict in the Middle East scrambling the outlook for commodity prices and growth, a fresh jump in consumer price inflation is a significant risk," the economist said. Oil and gas prices could drive a jump in energy prices from March, while a renewed slide in the yen is an added concern, Angrick said.
Consensus forecasts call for the BOJ to resume raising interest rates over the summer after it opted for a pause last week.
BOJ Gov. Kazuo Ueda has said more board members are concerned about the potential for prices to overshoot due to higher energy costs than about downside risks to growth. The central bank is also carefully monitoring the extent to which a weak yen will boost import costs.
Positive initial results from Japan's annual wage negotiations add to the case for a rate hike, signaling that the positive correlation between price and income growth the BOJ wants to see is taking root.
But the Middle East crisis could throw a wrench in that, too.
Economists at HSBC point out that while nominal pay is rising, real wages remain under pressure due to high inflation, a situation now complicated by energy price shocks.
S&P Global survey data flagged a downturn in sentiment among manufacturers and service providers because of the Middle East-driven rise in input costs. Employment weakened in March, and if businesses' margins get squeezed, firms could be more reluctant to raise wages.
HSBC's Justin Feng, Frederic Neumann and Akiko Kitamura expect just one 25-basis-point hike this year, in July, bringing the policy rate to 1.00%, but a prolonged Middle East conflict could bring that forward or add pressure for additional moves.
"That leaves the BOJ in a familiar stagflation bind: hike too soon and risk clipping fragile economic growth or hold back and risk further damage to household confidence--while also inviting renewed scrutiny from the US if yen weakness looks excessive," they said.
Write to Kosaku Narioka at kosaku.narioka@wsj.com and Fabiana Negrin Ochoa at fabiana.negrinochoa@wsj.com
(END) Dow Jones Newswires
March 24, 2026 01:26 ET (05:26 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
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