Tokyo’s CPI excluding food and energy rose 1.8% year on year in February. This compares with 2% in the previous reading.
This morning’s Tokyo core-core CPI data is a significant dovish signal, coming in at 1.8% and falling below the Bank of Japan’s 2% target for the first time in over a year. This slowdown from January’s 2.0% reading sharply reduces the market’s expectation for a near-term interest rate hike. We must now seriously question if a follow-up to the 2025 rate lift-off will happen this spring.
Implications For Bank Of Japan Policy
Last year, we saw the Bank of Japan finally exit its negative interest rate policy, a move that markets had anticipated for months. This set the stage for a gradual normalization path, with many of us pricing in another hike by the second quarter of 2026. This new inflation data, however, throws a wrench in that widely held view.
For currency traders, this should increase the appeal of shorting the yen. The interest rate differential with the U.S. will likely remain wide, putting downward pressure on the currency. We should consider buying USD/JPY call options, as a move from its current level of around 156 towards the 160 mark now seems more probable.
This environment is bullish for Japanese equities, as a weaker yen boosts the profits of major exporters. The Nikkei 225, which has been trading near record highs of 42,000, could get another tailwind from this news. We see value in buying Nikkei futures or call spreads to capitalize on potential further upside.
In the bond market, the reduced probability of a rate hike should push government bond yields lower. This makes going long on 10-year JGB futures an attractive trade over the coming weeks. Yields on the 10-year JGB, which had been creeping towards 1.0%, could now retreat back towards the 0.85% level.
Key Catalyst To Watch Next
The critical data point to watch now will be the results from the “shunto” spring wage negotiations. Even though recent wage growth was reported at a solid 2.6% year-over-year, this cooling inflation gives the Bank of Japan cover to wait for definitive proof of a strong wage-price spiral. With last quarter’s GDP figures showing an economy that narrowly avoided recession, the case for immediate tightening has weakened substantially.
