Japan's February Core CPI Drops Below 2% to 1.6%; Policy Subsidies Take Effect but Won't Hinder BOJ's Rate Hike Path

Core Overview: The latest data released by Japan's Ministry of Internal Affairs and Communications shows that the annual growth rate of the core consumer price index (Core CPI), excluding fresh food, in February 2026 (Q1 2026) dropped significantly to 1.6% from the previous 2.0%. This data performance is not only lower than the market consensus expectation of 1.7%, but it is also the first time it has fallen below the 2% inflation target line set by the Bank of Japan (BOJ) since March 2022. Overall, as the indicator slides rapidly, Japan's headline price pressure has significantly cooled.

Key Details: Delving into the composition of this CPI data, the decline is mainly driven by policy intervention and base effects. Under the government's resumption of electricity and natural gas subsidy policies, the annual decline in energy prices sharply expanded to 9.1%. In addition, the annual growth rate of regular food prices, excluding fresh food, also slowed to 5.7% from 6.2% in the previous month. However, it is worth noting that service inflation remained steady at 1.4%, and the annual growth rate of the "core-core CPI," which further excludes energy, was as high as 2.5%, indicating that the solid support for domestic demand prices in Japan's economy still exists.

In-depth Attribution: Regarding the weakening of the core CPI, market analysts generally attribute it to the result of strong official intervention. Abhijit Surya, senior Asia-Pacific economist at Capital Economics, pointed out that although headline inflation data is weak, underlying inflation pressures are actually more deeply entrenched, and the real price indicators valued by the BOJ will remain above 2% in the foreseeable future. To provide clearer guidance to the market, the BOJ has announced that it will introduce a new inflation measurement indicator in the summer that excludes the distortion effects of policies, thereby more accurately capturing the true inflation trend driven by domestic wages and demand, to serve as a rationalized basis for subsequent rate hikes.

Outlook and Risks: Looking ahead, in the short term (1-2 months), affected by the dual impact of the intensified conflict involving Iran in the Middle East and the weak Japanese yen, the surge in imported energy costs could push inflation to rebound upwards at any time. From a medium-term (3-6 months) perspective, the focus will entirely shift to the Bank of Japan's monetary tightening pace. Given that the core-core price indicators remain solid, the majority of the market expects that the BOJ's rate hike pace will not stall due to this data. The money market has currently priced in a rate hike probability of about 63% for April. Investors should closely monitor changes in the statements of the next few policy meetings and prepare early for potential volatility in the exchange rate and bond markets.

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