Japan's key inflation gauge accelerated for a second straight month in July, keeping the central bank on track for another near-term rate increase as speculation mounts over a possible move as soon as September. The Ministry of Internal Affairs reported Friday that the core consumer price index, excluding fresh food, rose 1.8% year-on-year, up from 1.6% in the prior month and matching the median estimate of economists.

Meanwhile, the index stripping out both fresh food and energy—a metric the Bank of Japan closely monitors for underlying price trends—advanced 1.9%, with the overall CPI also climbing 1.9%. The pickup was partly driven by energy costs, which increased 0.6% year-on-year, reversing a slight dip seen in June. As has been the case for some time, the headline figures were somewhat distorted by government measures aimed at cushioning the impact of higher energy costs. The ministry noted that gasoline tax cuts shaved 0.22 percentage points off the overall price increase.

This outcome gives the BOJ strong justification for hiking rates. Just weeks ago, Governor Kazuo Ueda indicated that policymakers could begin moving at a faster pace toward policy normalization. Investors are increasingly confident that the central bank will act next month, especially given that yen weakness continues to pose upside risks to prices, even after the rare joint currency intervention by Japanese and U.S. officials in late July.

Economist Taro Kimura commented that the July CPI report strengthens the case for the BOJ to stay vigilant against inflation overshooting. With oil prices surging between March and June and a softer yen pushing up input costs, inflation has ticked higher, while a low base from last year's energy subsidies also contributed to the acceleration. The BOJ has previously stated that the core CPI, excluding fresh food, is expected to exceed 2% "clearly" from the second half of the current fiscal year. Economists at Sumitomo Mitsui Nikko Securities forecast that this gauge could reach 2.8% at some point in the final quarter of the year.

Overnight index swap pricing now implies an approximately 80% probability that the BOJ will raise rates at its next decision on September 18. Processed food prices rose 3%, a relatively brisk pace by recent historical standards, though this was a slight slowdown from the 3.1% gain in the prior month, which acted as a drag on the overall index. Rice prices, after surging 91% a year ago when they were a major driver of headline inflation, dropped nearly 12%.

Services prices, a key indicator of inflation sustainability, advanced 1.2%, accelerating modestly from June. Beyond rising labor costs due to a tight job market, elevated oil prices stemming from Middle East conflicts and increased raw material expenses are prompting a shift in Japanese corporate pricing behavior. Companies are increasingly passing on higher costs to consumers rather than absorbing them internally. Data from Teikoku Databank shows that the number of food and beverage products with price increases this month is 83% higher than a year earlier.