Tokyo inflation greatly exceeds expectations! Bank of Japan's "overshoot alarm" soundsis a December rate hike a done deal?

As the effects of some temporary government measures fade, Tokyo's key inflation gauge rose sharply, supporting the Bank of Japan's stance of continuing to raise interest rates after authorities accelerated the pace of policy normalization. Data released Friday by the Ministry of Internal Affairs and Communications showed that Tokyo's consumer price index excluding fresh food rose 2.7% year-on-year in September. The reading was above the median economist estimate of 2.3% and higher than last month's 1.8% gain. This was the first time the gauge had reached 2% or above since January. The surge in CPI confirms the Bank of Japan's concerns about upside inflation risksrisks that could push core price trends beyond its 2% target. After accelerating normalization last month with its second rate hike in three monthsthe shortest interval since 1990the BOJ will look for the right timing for its next increase. The jump in the cost of living came even as Prime Minister Sanae Takaichi's energy subsidies continued to hold the headline gauge down by nearly 0.4 percentage points. Tokyo inflation excluding energy and fresh fooda key measure of underlying inflationrose to 3% from 2% a month earlier. Economist Taro Kimura said: "The report will reinforce the BOJ's view that core inflation is settling around its 2% targetand heighten concerns about rising overshoot risk. We expect the next 25 basis point hike in December." "This is a strong set of data. The effects of childcare and water bill relief are the main factor, but even without them, inflation is strong," said Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute. "Cost increases caused by Middle East conflicts are pushing up the cost of living, and unlike the deflation era, companies are passing on rising costs to consumers." Shinke said he expects the BOJ to raise rates in December, maintaining the current pace of hikes. Tokyo inflation had previously been suppressed by expanded childcare subsidies and summer water bill relief measures, and the market had widely expected a rebound in inflation. The biggest driver of the headline gain was processed food costs, which rose 3.6% year-on-year. According to a Teikoku Databank report, major Japanese food and beverage companies raised prices on 4,965 items last month, more than double a year earlier. Among the factors pushing inflation higher, water bills climbed sharply, rising about 66% year-on-year, while accommodation prices swung from a 1.4% decline last month to a 4.6% increase. Service pricesa key indicator of demand-driven inflationrose 2.3% year-on-year, the largest gain since November 2023. The BOJ's quarterly Tankan survey released Thursday showed that the business sentiment index for large Japanese companies improved for a sixth consecutive quarter. Benefiting from global AI demand and a shift in corporate behaviorcompanies beginning to pass on rising input costs to end consumerscorporate profits hit a record high in the second quarter, also signaling that inflation expectations are taking root. In addition, elevated oil prices and a weak yen may also keep inflation pressures high. Despite coordinated currency intervention by the United States and Japan in July and continued warnings, the yen remains hovering near the key psychological level of 160 per dollar. The yen strengthened slightly after the data release, trading around 158.19 per dollar on Friday. Earlier this week the yen weakened at one point, triggered by the summary of opinions from the BOJ's September monetary policy meeting showing that the central bank had no urgent desire to raise rates this month. The summary also showed that the Japanese government remains cautious about the BOJ's rate hike path. After several cabinet ministers previously commented, the market had briefly expected the government's stance might soften, but this meeting summary dispelled that speculation. "The upward trend in prices may spread further from October," said Shotaro Kugo, senior economist at the Institute for International Monetary Affairs. "The BOJ expects prices to rise in the second half of the fiscal year, and the trend in corporate procurement costs clearly points to an upward trajectory."