The persistence of inflation
Headline inflation decelerated to 3.5% year over year in May 2025, down from 4% in January.13 Much of this deceleration comes from food and beverages even though rice prices continued to surge. For example, year on year, rice inflation accelerated from 70.9% in January to 101.7% in May. Meanwhile, total food and beverage inflation slipped from 7.8% to 6.5% over the same period.14 Education prices also dropped considerably, thanks in part to government subsidies in Tokyo.15
Energy, food, and beverages have been some of the strongest drivers of headline inflation. However, other subcomponents of inflation have looked more benign. For example, western core inflation, which excludes food, beverages, and fuel costs, softened to 1.5% on a year-ago basis, down from 1.6% the previous month. Month to month, western core prices were flat in May.16
Some components of inflation are expected to ease this year. Rice prices fell for three consecutive weeks ending June 8, which should take at least some of the pressure off inflation.17 The declines have been relatively modest so far, but prices are now moving in the right direction. A stronger yen is also expected to ease import prices and limit the rebound in energy-related inflation that could come from the recent rise in crude-oil prices globally. Real consumer spending has been relatively muted, while real wages are falling, which will make it more challenging for businesses to raise prices in the near term.
Below-target western core inflation and an anticipated slowdown due to a changing global trade landscape suggest that monetary policy will remain on hold for at least the rest of this year. Indeed, the Bank of Japan expects that inflation will ease to just 2% in the fiscal year ending March 2026, down from the 2.2% previously forecasted.
The central bank’s outlook for GDP has come down even more substantially to 0.5% from a previously forecasted 1.1%.18 The Bank of Japan is also expected to slow the pace of its cuts to government-bond purchases early next year in an effort to allow for additional support to the economy.19
There is still a nontrivial chance that the central bank will have to tighten policy sooner than anticipated. For one, a favorable trade agreement would likely pull forward the timing of the next rate hike. There is also evidence that services inflation is beginning to accelerate. Falling food prices could fuel more demand for such services and drive prices higher. At the same time, all three of the Bank of Japan’s underlying inflation measures (trimmed mean, median, and mode) have accelerated through April—though median and modal inflation are still below the 2% threshold.20 Inflation expectations also continue to move higher, which could force monetary policymakers to adopt a more hawkish position to prevent expectations from turning into reality.21
