(Bloomberg) -- Japan’s inflation slowed in line with expectations while services showed signs that underlying price growth is spreading more widely in the economy, a key trend followed by the central bank amid ongoing speculation it will pare back its stimulus in coming months.

Consumer prices excluding fresh food items rose 2.5% from a year ago as falls in energy costs deepened and gains in processed food prices eased, the internal affairs ministry reported Friday. The result matched forecasts by economists.

Service prices meanwhile rose by 2.3%, the fastest pace since October 1993 excluding the impact of sales tax hikes, in an indication that inflation may be moving beyond temporary cost-push factors.

The latest figures fit in with earlier data for Tokyo and the BOJ’s view that price pressures will gradually cool as import-driven inflation subsides with the focus on whether a wider trend supported by wage growth takes root. 

The inflation gauge is under close scrutiny as economists and investors try to determine the timing of a likely move by the Bank of Japan to raise interest rates for the first time since 2007. The bank decided to stand pat at its latest policy meeting earlier this week and offered little indication of when it will scrap its negative rate. Two-thirds of BOJ watchers expect it to move by April.

“The BOJ governor said at his press briefing the other day that he was closely watching service prices, so this is a positive movement for the central bank,” said Kohei Okazaki, senior economist at Nomura Securities Co. “The question is how far you need to look before having the confidence you can see the 2% stable inflation target, so inevitably it’ll have to be a holistic decision.”

Okazaki sees the central bank scrapping its negative interest rate in January and waiting until April to abandon its control of bond yields in April, a stepped approach that may help limit the shock factor for markets. 

The consensus among economists surveyed by Bloomberg earlier this month is for the BOJ to raise rates by April after checking on the results of annual pay negotiations due in March. 

“The spring wage results are important, but from what we can see, the BOJ is also getting a lot of information from hearings for their branch managers’ meeting, so I think it’s whether there is evidence of progress in the moves to shift labor costs to prices or not,” said Mari Iwashita, chief market economist at Daiwa Securities Co.

The report showed that a deeper measure of the inflation trend that strips out fresh food and energy prices decelerated to 3.8%, also in line with forecasts. Some economists have focused on this measure of prices as a truer indication of where inflation lies as it factors out volatile energy prices that have also been affected by government subsidies.

Prime Minister Fumio Kishida has extended the aid to lower household bills through the end of April as he tries to ease the pressure of inflation on voters amid simmering public discontent with his administration, exacerbated by a ruling party fund-raising scandal.

Electricity prices fell 18% in November from a year earlier, a tad more than in the previous month. Subsidies for electricity and and gas shaved around a half percentage point off the overall inflation figures, according to the report. 

What Bloomberg Economics Says...

“Critically, demand-led inflation the BOJ wants to see is still hardly evident. All in all, the CPI report reinforces our view that the central bank will maintain stimulus through the first half of next year.”

— Taro Kimura, economist

For the full report, click here. 

Prices of processed food gained 6.7%, compared with a 7.6% drop in October. Combined with the fall in energy prices, that accounted for about three-quarters of the slowdown in monthly inflation. After widespread gains in food prices over the past year and a half, the number of food items scheduled for price increases in 2024 decreased by 80% compared with a year ago, according to a report by Teikoku Databank.

Beyond the inflation data, the central bank will also likely consider the strength of the overall economy when it finally decides on raising rates.

Gross domestic product figures to be released in February are expected to show the economy returning to growth, another factor that suggests the central bank will wait until spring before making a move.

The Japanese economy suffered its deepest contraction since the height of the pandemic in the summer, as consumers cut spending amid prolonged price hikes. The cooling prices could help boost consumer spending that drives more stable, demand-driven inflation.

“The environment is getting better,” said Iwashita. “So it’s just a matter of when the final decision will be made, January, March, or April.”

--With assistance from Mia Glass.

(Adds economist’s comments)

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