BOJ Faces Dilemma as Japan's Inflation Accelerates to 2.7%

Japan's inflation is becoming harder for the Bank of Japan (BOJ) to ignore. Tokyo core Consumer Price Index (CPI) rose 2.7% in September, up from 1.8% in August and above the market forecast of 2.4%. The index excluding fresh food and fuel accelerated to 3.0%, and service inflation increased sharply to 2.3%. This suggests that higher labour costs are increasingly passing through to prices.

The BOJ is now facing a policy dilemma. On one hand, imported energy inflation can fade when oil prices fall. On the other hand, broader services inflation can become more persistent. The government has approved a plan to reduce the consumption tax on food from 8% to 1% for two years from April 2027, which may ease household costs but could add pressure on government finances and bond yields.

The BOJ raised its policy rate to 1.25% in September, the highest level in more than three decades. Markets have consequently moved toward a more measured path, with an October hold increasingly reflected in pricing and expectations of another increase later in the year. The next policy meeting is scheduled for October 29-30.

The BOJ's reaction function will be closely watched to see how it responds to the accelerating inflation. If inflation continues to accelerate while wages and services remain firm, the market may reassess how far Japan's policy rate ultimately needs to move.