oaring oil and commodity prices hit Japan's economy with a one-two punch in May, thrusting up inflation, driving consumers to tighten their pocketbooks and threatening to derail the country's modestly growing economy.
Japan's core inflation excluding volatile fresh food prices rose 1.5 percent in May from a year earlier, the quickest pace since a consumption tax hike in March 1998, the government said Friday.
Household spending in May, meanwhile, sank 3.2 percent from the previous year, according to the Ministry of Internal Affairs and Communications. That was worse than a market forecast for a 2 percent decline and marked the deepest slump since September 2006.
"Rising oil and commodity prices are pushing up costs, which is damaging corporate profits and consumer sentiment," said Economy Minister Hiroko Ota, according to Kyodo news agency. "We need to continue to monitor the situation."
Other numbers were a bit more upbeat: industrial production in May rose 2.9 percent from the previous month as manufacturers boosted output of mobile phones and cars, and the jobless rate remained flat at 4 percent.
Retail sales inched up 0.2 percent from a year earlier on higher fuel and food prices, the government said in a separate report.
Until last year, Japan had struggled with deflation, or falling prices. But Friday's data indicates that global factors are exerting upward pressure on basic living expenses such as fuel and non-fresh foods.
White bread prices were up 12.0 percent from a year earlier. Spaghetti leapt 32.2 percent, and instant noodles jumped 20.7 percent. Gasoline cost 18.0 percent more, and kerosene prices rose 27.6 percent.
On top of record crude oil prices — which rose above $141 a barrel for the first time Friday — Japanese drivers paid more at the pump after the government reinstated a gas tax that had been temporarily suspended in April.
The CPI data further highlights the policy dilemma facing Bank of Japan: rising inflation coupled with a slowing economy.
Economists are forecasting virtually zero growth or even a contraction in the world's second largest economy in the April-June quarter and over the months ahead.
As such, the central bank is likely to keep its key interest rate on hold at 0.5 percent for the time being even in the face of inflationary pressures, said UBS economist Akira Maekawa in a research report Friday.
Japan's benchmark Nikkei 225 stock index plunged 2 percent to to a two-month low of 13,544.36, dragged down by an overnight tumble on Wall Street, skyrocketing global oil prices and the government's lower assessment of industrial production.
Takehiro Sato, chief economist at Morgan Stanley in Tokyo, predicts that inflation in Japan is headed even higher. Core CPI could hit 2 percent later this year, he said, and might even reach 2.5 percent by April 2009.
Inflation driven by increases in frequently-purchased items is cause for concern, Sato said, countering some analysts' views that inflation in Japan can spur a broader recovery in domestic demand.
"Possibly, (foreign observers) are misunderstanding the situation in Japan," he said.
Energy prices contributed significantly to inflation. Stripping out food and energy, CPI was down 0.1 percent, a sign that Japan's underlying inflation is stable.
"It's all a story of imported inflation effects rather than domestic momentum," said Richard Jerram, an economist for Macquarie in Tokyo.
He pointed to the rise in industrial production as evidence that the economy is hitting turbulence but isn't undergoing a serious downturn.
However, the government downgraded its assessment of manufacturing activity, calling it "flat" with a "few weakening factors." It projects production to fall 0.9 percent in June and increase 2.2 percent in July.
"You would've thought that if there was a serious deterioration in demand conditions, you'd be seeing inventories pushing quite a lot higher and that's not happening," Jerram said. "So I think it suggests that yes, exports are hitting a difficult period, and that's going to have an impact on industrial production. It's going to be a struggle for the next six months, but it's not a particularly frightening development."