Japanese annual wholesale inflation hit a 27-year high of 3 percent in January due to rising oil and other raw material costs, but the Bank of Japan is likely to sit tight on rates in the face of cost-push inflation and slowing global growth.
The data follows a pessimistic outlook from financial chiefs in the Group of Seven industrialised countries when they met in Tokyo on Saturday, amid fears of a recession in the United states in the wake of the subprime crisis.
Reinforcing fears of a slowdown that would hit exports, Japan's current account shrank more than expected in December from a year earlier.
Fears that the Japan could be hit by a U.S. slowdown have prompted investors to speculate the BOJ may follow the U.S. Federal Reserve in cutting interest rates later this year.
While Japan has long sought to get out of deflation, economists said price increases forced by rising energy and material costs, rather than increasing demand, was not the kind of inflation Japan wanted.
"The rise in wholesale prices doesn't mean it will help the BOJ raise rates in the near future because the BOJ is fully aware of the risk of the economy from cost-push inflation," said Azusa Kato, an economist at BNP Paribas.
"Our main scenario is for the BOJ to sit tight until late 2009 but it could cut rates in April-June this year if the U.S. economy suffers a further pronounced slowdown."
The 3.0 percent rise in the corporate goods price index, which tracks wholesale prices of goods, in January from a year earlier, was the highest annual rise since a 3.8 percent rise in March 1981 and topped market expectations for a 2.8 percent rise.
Economists expect the rising wholesale inflation to push up the core consumer price index to 1.0 percent in annual terms in coming months.
BOJ Stuck on Hold
The BOJ has stuck to its stance of gradually lifting rates from current rock-bottom levels as long as the positive economic cycle is in tact, but BOJ Governor Toshihiko Fukui has recently admitted that such a mechanism was weakening.
Financial markets showed a muted reaction to the price data and investors expect the central bank to keep its key overnight call rate on hold at 0.5 percent at a two-day policy review that ends on Friday.
The pace of rises in wholesale prices in comparison with a year ago has been picking up in recent months and putting upward pressure on consumer prices,although firms facing slack consumer demand have been reluctant to pass on rising costs to consumers.
Japan's annual core consumer price index, which excludes volatile fresh fruit, vegetable and fish prices but includes oil products, hit a decade-high 0.8 percent in December, due largely to surging oil and other commodity prices.
Japan's current account surplus fell 4.7 percent in December from a year earlier, a bigger fall than the 3.6 percent decline expected by analysts, reflecting a decline in Japanese exports to the United States.
Economists have said slowing exports in light of faltering demand from the United States is clouding the outlook for Japan, which has relied heavily on exports for growth in recent years.
But a Reuters poll last week showed that economic growth in the last quarter of 2007 likely kept pace with the previous quarter as firm exports and capital investment offset a sharp fall in housing investment.
The poll of 34 economists produced a median forecast of a 0.4 percent rise in gross domestic product in the world's second-largest economy in October-December.
Preliminary GDP data for October-December will be released on Thursday at 8:50 a.m. (2350 GMT Wednesday).