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By Leika Kihara
TOKYO (Reuters) -Core inflation in Japan's capital hit 2.5%, marking the fastest annual pace in nearly a year, well exceeding the central bank's 2% target and keeping alive market expectations for further interest rate hikes.
The data released on Friday follows the Bank of Japan's decision last week to raise interest rates to 0.5%, the highest since the 2008 global financial crisis but still far below that of other major economies.
The increase in the Tokyo core consumer price index (CPI), which excludes volatile fresh food costs, matched a median market forecast and followed a 2.4% gain in December.
The Tokyo index, considered a leading indicator of nationwide trends, accelerated for the third straight month with the year-on-year rise matching a high hit in February last year.
Some analysts expect inflation to accelerate towards 3% in coming months as a stubbornly weak yen continues to push up import costs, keeping the BOJ under pressure to hike rates.
"Price pressures from rising raw material costs are proving stickier than expected, which may prevent real wages from turning positive and hurt consumption," said Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute, adding that nationwide core inflation may approach 3% in May.
"Just looking at inflation, the BOJ might see scope to raise interest rates once or twice this year. But much depends on whether consumption and the broader the economy hold up."
A separate index for Tokyo that strips away both fresh food and fuel costs and is closely watched by the BOJ rose 1.9% in January from a year earlier after increasing 1.8% in December, the data showed.
Prices increased for food, fuel and a broad range of goods in a sign of the hit households face from rising living costs, the data showed.
The overall Tokyo CPI, which includes fresh food, rose 3.4% in January from a year earlier, marking the fastest pace in nearly two years on soaring prices of vegetables and rice.
The BOJ exited a decade-long, radical stimulus programme last year and embarked on a rate-hike cycle analysts say may eventually push up short-term rates to around 1% from 0.5% currently.
Governor Kazuo Ueda has said the BOJ will continue to push up borrowing costs if continued wage gains underpin consumption and allow firms to raise prices, thereby keeping inflation stably around its 2% target.
In fresh quarterly forecasts released last week, the BOJ sharply revised up its fiscal 2025 inflation forecast citing longer-than-expected pressure from rising raw material costs.
Ueda said such cost-push pressure will likely dissipate in the latter half of fiscal 2025, providing households some relief.
While many firms are signalling readiness to keep boosting pay amid intensifying labour shortages, there is uncertainty on whether wages will rise fast enough to compensate households for rising living costs.
Services inflation in Tokyo hit 0.6% in January, slowing from 1.0% in December, suggesting price rises continue to be driven more by rising raw material costs than wage gains.
Underscoring the fragile nature of Japan's economy, separate data showed factory output rose just 0.3% in December from the previous month. Manufacturers surveyed by the government expect output to rise 1.0% in January and 1.2% in February.
(Reporting by Leika Kihara; additional reporting by Satoshi Sugiyama; Editing by Sandra Maler and Sam Holmes)
