(Bloomberg) -- Japan’s inflation accelerated on the back of rising energy costs, a result that backs the case for the central bank to consider raising interest rates in coming months.

Consumer prices excluding fresh food rose 2.5% in May from a year ago, quickening from 2.2% in April, the ministry of internal affairs said Friday. The reading came in a tad below economists’ consensus while staying at or above the Bank of Japan’s 2% target for a 26th month. Inflation was driven by a 14.7% jump in electricity prices.

The nationwide results were roughly in line with May figures for Tokyo released three weeks ago.

The main gauge re-accelerated after two months of deceleration, providing a rationale for the central bank to consider raising interest rates as early as next month, when the BOJ has said it will provide details about its plans to reduce bond buying. Whether Friday’s report is strong enough to prompt a move is open to question, according to Nobuyasu Atago, chief economist at Rakuten Securities Economic Research Institute.

“The rebound in CPI was within an expected range and I don’t think this report alone will be a decisive factor for the BOJ’s next rate hike,” Atago said. “I don’t think the BOJ can say that certainty for hitting the 2% price goal has increased because of this report alone.” 

Atago said the BOJ may have to wait to hike until after it sees second-quarter economic growth data due for release in August.

What Bloomberg Economics Says...

“The pickup was led mainly by a cost-push factor, not by increased demand. There was little evidence that faster wage growth bolstered service inflation, which has been the scenario the BOJ has been betting on. Still, the core gauge climbing further above the 2% inflation target is consistent with the central bank’s price outlook.”

— Taro Kimura, economist

For the full report, click here. 

For now, Governor Kazuo Ueda is keeping his options open. Asked last week if authorities might be able to raise rates at the same meeting, Ueda replied “of course,” as long as data warrant such a move. He further highlighted the possibility of an early hike when he said in parliament Tuesday that there’s a good chance the policy rate will be raised next month, depending on economic and financial conditions.

Still, there’s reason for caution. A deeper measure of inflation that strips out fresh food and energy prices rose 2.1% in May, marking a ninth consecutive month of cooling, and growth in service prices, which the BOJ has highlighted as a key factor in its policy deliberations, edged lower to 1.6% after slowing sharply to 1.7% in April. That deceleration may hint at a growing reluctance by businesses to raise prices further, as higher costs have increasingly damped consumer appetites. 

“Services inflation is weak, which is negative for monetary policy,” said Atsushi Takeda, chief economist at Itochu Research Institute. “The ideal situation would be for wage gains to be passed on to prices and for prices to rise stably.”

Among the components weighing on the index was processed food, for which price growth slowed to 3.2% partly due to base effects. The number of food items that saw price increases in May was less than half the figure in the same month last year, according to the latest survey by Teikoku Databank.

Going forward, there are both upside and downside factors affecting prices. One of the main factors pushing prices higher is the weak yen. Japan’s currency has traded within a few yen of its 34-year low to the dollar for much of the past month.

The yen was trading around 158.85 to the dollar Friday morning in Tokyo, prompting a volley of verbal intervention. Top currency official Masato Kanda said there’s no change in his stance to take appropriate measures if there are excessive currency moves.

The continuing wide gap between Japanese interest rates and those of its peers is expected to keep pressure on the yen against a range of currencies and refuel import-driven price hikes. Trade data for May showed that Japan’s trade deficit widened to more than ¥1 trillion ($6.3 billion), as the weak currency inflated import bills.

Ueda has said authorities need to monitor how the yen and import prices are affecting the broader economy.

Another upside risk stems from energy policies. The government began phasing out utility subsidies in May, steps that reduced consumer electricity and gas bills by as much as 20% at one point. Economists see the termination of the utility subsidies, together with the increase in a renewable energy levy, pushing the inflation rate up toward 3% over the summer.

On the other hand, tepid consumption is a factor cooling inflation. Japan’s consumer sentiment worsened the most in two years in May, as households were increasingly concerned about persistent inflation. 

Whether Japan can achieve a virtuous economic cycle linking wages to demand-led price gains is also a key part of Prime Minister Fumio Kishida’s agenda, as he seeks an exit from deflation. Wage gains seen taking effect from June and the government’s income tax rebate are expected to boost customers’ disposable income. The extent to which the added income spurs consumption — and prices — remains to be seen. 

The premier is pinning his last hope on economic uplift, as his chances of leading his long-ruling Liberal Democratic Party into the next election look to be fading. Two polls over the weekend showed voter approval slid to its lowest since he took office in 2021.

--With assistance from Yoshiaki Nohara and Keiko Ujikane.

(Updates with details with economists’ comments)

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