Nikkei 225 rallies nearly 2%, but Japan’s inflation story is getting hotter

Japan’s Nikkei 225 climbed on Thursday as a benign US inflation report eased pressure on global interest rates, giving technology and export shares another lift even as domestic price data strengthened the case for a Bank of Japan hike next month.

The Nikkei gained about 1.9%, extending a rebound that has taken the benchmark back towards recent highs.

South Korea’s KOSPI jumped 4.4%, while MSCI’s broadest Asia-Pacific index outside Japan rose about 1%.

The regional rally followed modest gains on Wall Street after July US inflation matched expectations, but Japan faces a more complicated rates story than its neighbours.

Softer US inflation gives the Nikkei room to run

The immediate support for Japanese stocks came from Washington rather than Tokyo.

US consumer prices increased 0.1% in July and 3.4% from a year earlier, down from June’s 3.5% annual pace.

Core inflation rose 0.2% on the month and eased to 2.5% annually. The figures were close to economists’ expectations and reduced the urgency for another Federal Reserve increase in September.

Markets cut the implied probability of a September Fed hike to about 40%, from 54% a week earlier.

Lower US rate expectations are particularly helpful for growth and technology shares because they reduce pressure on valuations and global borrowing costs.

That backdrop helped the Nikkei outperform despite a fairly restrained Wall Street lead. The S&P 500 rose 0.3% on Wednesday, the Nasdaq Composite gained 0.5% and the Dow slipped fractionally.

The broader Asian move was stronger. The KOSPI surged 4.4% as investors returned to beaten-down semiconductor names, while Hong Kong and mainland Chinese equities posted smaller gains.

Australia’s S&P/ASX 200 moved lower, leaving Japan and South Korea as the clearest beneficiaries of the softer global rates trade.

Japan’s own inflation story is moving the other way

The complication for the Nikkei is that Japan’s domestic inflation picture is becoming less comfortable.

Bank of Japan data showed producer prices rising 7.2% in July from a year earlier, barely easing from a revised 7.3% gain in June. Prices rose another 0.1% from the previous month.

The details suggest inflation is spreading well beyond energy. Nonferrous-metal prices surged more than 40% from a year earlier, while chemical-product prices also posted double-digit gains.

The yen-based import-price index rose 29.1%, highlighting how currency weakness continues to increase the cost of overseas goods.

Sompo Institute Plus economist Masato Koike expects renewed Middle East pressure on crude prices and continued yen weakness to keep wholesale inflation elevated.

In his assessment, those forces make a September BOJ increase increasingly plausible.

The yen traded near 159.3 per dollar on Thursday, reinforcing the tension facing Japanese equities.

A weak currency supports overseas earnings for exporters, but it also raises import costs and strengthens the argument for tighter monetary policy.

Oil and the BOJ keep the rally from becoming straightforward

Energy remains another risk for Japan, which depends heavily on imported fuel.

Brent crude eased about 0.7% to $88.35 a barrel on Thursday, while West Texas Intermediate fell to $82.58.

Prices remain elevated as the US and Iran struggle to revive an agreement over the Strait of Hormuz.

For the Nikkei, lower oil would provide a useful counterweight to rising domestic input costs.

Another crude surge would do the opposite, squeezing corporate margins while adding to pressure on the BOJ to tighten.

That leaves Japan’s benchmark in an unusual position. Softer US inflation is improving the global backdrop for equities just as Japan’s own price data argue for higher domestic rates.

The Nikkei can continue benefiting from stronger technology sentiment and a weak yen, but Thursday’s 7.2% wholesale-inflation reading means investors cannot treat the global shift towards easier rate expectations as a purely bullish story for Tokyo.