Key inflation gauges in Tokyo surged sharply as the effects of some temporary government measures faded, reinforcing the Bank of Japan's position to keep raising interest rates after authorities accelerated the pace of policy normalization.

Data released Friday by the Ministry of Internal Affairs and Communications showed that Tokyo's consumer price index excluding fresh food rose 2.7% year-on-year in September. That reading topped the median economist estimate of 2.3% and exceeded the prior month's 1.8% gain. It was the first time the gauge reached 2% or above since January. The jump in CPI underscores the BOJ's concern about upside inflation risks that could push core price trends beyond its 2% target.

After quickening its normalization pace last month with a second rate hike within three months, the shortest interval since 1990, the BOJ will look for the right moment for its next move. The jump in the cost of living came even as energy subsidies from Prime Minister Sanae Takaichi kept the headline gauge about 0.4 percentage points lower overall. Tokyo inflation excluding energy and fresh food, a key measure of underlying inflation, climbed to 3% from 2% a month earlier.

Taro Kimura, an economist, said the report will strengthen the BOJ's view that core inflation is settling around its 2% target and heighten concerns over rising overshoot risk. He expects the next 25 basis point hike in December.

"This is a strong set of data. The impact of childcare and water fee reductions is the main factor, but even without those, inflation was strong," said Yoshiki Shinke, senior executive economist at the Dai-ichi Life Research Institute. "Rising costs from Middle East conflicts are pushing up the cost of living, and unlike the deflation era, companies are passing on higher costs to consumers." Shinke said he expects the BOJ to raise interest rates in December, maintaining the current pace of hikes.

Tokyo inflation had been suppressed by expanded childcare subsidies and summer water fee reductions, and the market had widely anticipated a rebound. The biggest driver of the headline gain was processed food costs, which rose 3.6% year-on-year. According to a report by Teikoku Databank, major Japanese food and beverage companies raised prices on 4,965 items last month, more than double the level a year earlier. Among the factors pushing inflation higher, water fees jumped about 66% year-on-year, while accommodation prices swung to a 4.6% increase from a 1.4% decline the previous month. Service prices, a key gauge of demand-driven inflation, rose 2.3% year-on-year, the largest gain since November 2023.

The BOJ's quarterly Tankan survey released Thursday showed the sentiment index for large Japanese manufacturers improved for a sixth straight quarter. Helped by global AI demand and a shift in corporate behavior, with companies beginning to pass on rising input costs to end consumers, corporate profits hit a record high in the second quarter, signaling that inflation expectations are taking hold. In addition, elevated oil prices and a weak yen may keep inflation pressure stubbornly high.

Despite coordinated currency intervention by the United States and Japan in July and persistent warnings, the yen is still hovering near the key psychological threshold of 160 per dollar. The yen strengthened slightly after the data release, trading around 158.19 per dollar on Friday. Earlier in the week the yen weakened after a summary of opinions from the BOJ's September monetary policy meeting showed the central bank had no urgent desire to raise interest rates this month. The summary also showed the Japanese government remains cautious about the BOJ's rate hike path. Several cabinet ministers had previously signaled that the government's stance might soften, and the minutes dispelled that speculation.

"Price increases may spread further from October," said Shotaro Kugo, senior economist at the Institute for International Monetary Affairs. "The BOJ expects prices to rise in the second half of the fiscal year, and the trend in corporate procurement costs clearly points to an upward trajectory."