Japan: Is 2% Inflation Attainable?

Japan: Still aiming to get inflation to 2% on a consistent basis

The hoped-for attainment of a consistent 2% inflation rate is, once again, likely to be disappointed.

To be sure, the headline (all items) inflation rate is above 2% and has been for three years. But underlying measures of inflation, inflation expectations, money growth and real growth prospects all indicate that low inflation has not yet been conquered.

There is a wide range of underlying inflation measures. Bank of Japan Governor Ueda commented at the ECB Sintra Forum in July 2025 about the three main elements of the inflation trend.

First, underlying inflation as determined by wage-price dynamics. There is a wage-price spiral, at the moment, amplified by resilient domestic demand. This element is going up slowly but is somewhat below 2%.  Second, the effect of tariffs which is expected to be negative: it is a broadly deflationary influence.

Third, domestic supply shocks driven by increases in food prices. Food prices account for about 50% of headline inflation. Components 1 and 2 will produce a slow increase in underlying inflation to around 2% by end 2026/start of 2027 in Ueda’s view. The third component will subside towards the end of 2025. Prospect for the policy interest rate depend on these three dynamics.

Inflation expectations remain weak. Commenting at the October 2024 IMF meetings, Governor Ueda commented that “When inflation expectations are so low, it takes a long time to change them.” With huge uncertainty he wanted to proceed “cautiously and gradually”. That seems exactly what is happening. 

Growth of the broad money supply – just 0.8% year-on-year is insufficient to support 2% inflation and modestly positive real GDP growth, in our view.

Governor Ueda sees the natural real rate of interest “somewhere between -1% and +0.5% but thinks that each of these estimates comes with big confidence interval.” If 2% inflation cannot be achieved – maybe 1% is more realistic – that points to nominal interest rates ending up at between 0% and +1.5%.

In other words, there is little room for raising rates any further.