ISM manufacturing prices index surged to 77.9 in September, complicating Fed's next move

Tokyo's core inflation rate surged in September, marking the quickest pace in nearly a year and providing compelling evidence for the Bank of Japan to consider additional interest rate increases, according to recent data. This surge in core inflation underpins the argument for further monetary tightening by the central bank, which will be factored into their upcoming quarterly inflation forecasts during their policy meeting on October 29-30.

Although financial markets have decreased the probability of two consecutive rate hikes this month, many analysts predict a December rate increase to avert potential inflation overshoot. Even after accounting for temporary factors, the inflation figures are robust and indicate companies are persistently passing on higher costs stemming from the weak yen and the ongoing Iran war.

Yoshiki Shinke, a senior executive economist at Dai-ichi Life Research Institute, noted that even after adjusting for one-off factors, the inflation data remains strong, and businesses are effectively transferring the surge in costs from the weak yen and the Iran war to consumers. Nationwide core inflation is anticipated to surpass 3% in the upcoming months, with the BOJ facing a potential rate hike as early as December due to the upside risks to underlying inflation.

In Tokyo, the core consumer price index increased by 2.7% in September compared to the same period a year ago, surpassing the previous month's 1.8% rise and exceeding the Bank of Japan's 2% target for the first time since January. This rate of increase was the fastest annual growth since November 2025, highlighting the accelerating inflation trend driven by rising energy costs from the Middle East conflict and subsequent second-round effects.

The index excluding volatile fresh food and fuel prices, which the BOJ closely monitors as a superior gauge of underlying inflation, rose by 3.0% in September, its fastest annual increase since August 2025. Prices of various food items and daily necessities surged due to higher raw material costs, while households also faced increased expenses for electronic devices like personal computers and tablets, attributed to a spike in chip prices.

Core inflation continued to accelerate as a trend, driven by the rising energy costs stemming from the Middle East conflict and the subsequent second-round effects. Masato Koike, a senior economist at Sompo Institute Plus, anticipates the BOJ to raise its policy interest rate in December, emphasizing that firms in the service sector are also passing on rising labor costs resulting from a tight job market.

The Bank of Japan raised its key rate to a 31-year high last month, signaling that the bank has entered a phase focused on preventing underlying inflation from surpassing its 2% target, which implies the possibility of more rate hikes. The central bank has indicated that underlying inflation, which strips away one-off factors, is close to its 2% target but has not yet achieved it.

The main driver would be how the recent hikes in wholesale and consumer prices influence public perception of future price movements, a crucial element for anchoring underlying inflation around the BOJ's target, according to analysts. In July, the BOJ projected core consumer inflation of 2.5% for fiscal 2026 and 2.4% for 2027, reflecting the cost pass-through from the Middle East conflict.

Analysts are closely monitoring whether a renewed rise in crude oil prices could lead the BOJ to revise its inflation forecasts upwards in October, as the second wave of the energy shock could prolong elevated inflation beyond expectations, potentially strengthening the case for hawkish sentiment within the BOJ board.