Japan's core inflation slows on fuel subsidies, demand-driven pressure intact

By Leika Kihara

TOKYO (Reuters) - Japan's core inflation slowed in September due to the rollout of energy subsidies but an index excluding the effect of fuel held steady, a sign that broadening price pressure will keep the central bank on track to raise interest rates further.

The data will be among factors the Bank of Japan (BOJ) will scrutinise at this month's policy meeting, when the board releases fresh quarterly growth and price forecasts.

The core consumer price index (CPI), which includes oil products but excludes fresh food prices, rose 2.4% in September from a year earlier, data showed on Friday, compared with a median market forecast for a 2.3% gain.

The slowdown from a 2.8% rise in August was due largely to the government's roll-out of temporary subsidies to curb gas and electricity bills, which will likely weigh on core inflation in coming months.

An index stripping away the effects of fresh food and fuel, which is closely watched by the BOJ as a better indicator of demand-driven price moves, rose 2.1% in September year-on-year after a 2.0% gain in August.

"We expect inflation excluding fresh food and energy to remain around 2% until early next year, when it should gradually fall below 2%," said Marcel Thieliant, head of Asia-Pacific at Capital Economics.

"Accordingly, we still expect the Bank of Japan to press ahead with another interest rate hike before year-end."

Japan's core consumer inflation has exceeded the BOJ's 2% target for well over two years, prodding the BOJ to end negative rates in March and raise short-term rates to 0.25% in July.

BOJ Governor Kazuo Ueda has said the bank will keep raising rates if inflation remains on track to stably hit 2% as it projects. But he stressed the bank will spend time gauging how global economic uncertainties affect Japan's fragile recovery.

Japan's economy expanded an annualised 2.9% in the second quarter as steady wage hikes underpinned consumer spending, though soft demand in China and slowing U.S. growth cloud the outlook for the export-reliant country.

Ueda has said the driver of inflation must shift to solid domestic demand and wage growth, from rising raw material prices, for inflation to durably hit 2%.

That has put the focus on whether higher wages will prod firms to hike prices for services.

Service inflation slowed to 1.3% in September from 1.4% in August, the CPI data showed, a sign companies were passing on rising labour costs only at a moderate pace.

No policy change is expected at the BOJ's next rate review on Oct. 30-31, though markets are divided on whether the bank could hike rates in December or wait until January.

A slim majority of economist polled by Reuters saw the BOJ forgoing a hike this year, with most expecting the central bank to raise rates again by March next year.

(Reporting by Leika Kihara; Editing by Sonali Paul and Sam Holmes)