By Leika Kihara
TOKYO (Reuters) - Japan's annual core consumer inflation ticked up slightly in August but remained distant from the central bank's 2 percent target, suggesting that monetary policy will stay ultra-loose for the time being.
The proportion of items in the inflation gauge that rose in price last month hit its lowest in nearly five years, underscoring the challenge the Bank of Japan faces in wiping out the country's entrenched deflationary mindset.
Soft inflation poses a challenge for Prime Minister Shinzo Abe's efforts to put a sustained end to deflation as he heads into a third term, though he has recently distanced himself from the central bank's elusive target.
"Inflation will hover around current levels until early next year but probably won't accelerate well above 1 percent, dashing the BOJ's hopes," said Daiwa Securities Chief Market Economist Mari Iwashita.
"Abe's recent remarks suggest the government is no longer insisting that the BOJ's price target be met."
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The nationwide core consumer price index (CPI), which excludes fresh food costs, rose 0.9 percent in August from a year earlier, matching a median market forecast and picking up slightly from a 0.8 percent gain in July.
The so-called core-core index, a more closely watched gauge the BOJ uses to strip away the effect of both energy and fresh food costs, was up 0.4 percent in August after rising 0.3 percent in July, government data showed on Friday.
Stubbornly soft inflation has dashed the BOJ's hopes that solid economic growth will translate into higher prices, and could delay the central bank's exit from ultra-easy policy.
Of the items composing core CPI, 49.3 percent saw prices rise in August from a year earlier, slipping to the lowest level since November 2013, the data showed.
Prices of goods ranging from processed food to medicines were starting to fall again, a government official briefing reporters on the data said, suggesting that weak consumption was sapping firms' pricing power.
A spike in the prices of vegetables and other fresh foods, blamed on heavy rain in June and July, may prevent households from boosting discretionary spending, some analysts say.
Overall consumer prices, which include fresh food costs, jumped 1.3 percent in August from a year earlier, accelerating from 0.9 percent in July.
"Core consumer inflation will probably peak around September or October," said Kyohei Morita, chief economist at Credit Agricole Securities. "We expect the BOJ to maintain interest rates at current levels until 2020."
Subdued wage and price growth has forced the BOJ to maintain its massive stimulus despite some side effects, notably the hit to bank profits from prolonged near-zero interest rates.
The BOJ kept monetary policy steady on Wednesday and its governor stressed that the bank won't pull the plug on monetary easing until inflation hits its elusive target.
Former BOJ Deputy Governor Toshiro Muto said stubbornly weak price growth may force the BOJ to hold off on raising rates for years unless it ditches its ambitious inflation target.
"As long as the BOJ sticks to its 2 percent inflation target, there's no choice but to maintain its current monetary easing," Muto told Reuters. [L3N1W72MK]
Japan's economy rebounded in the second quarter from a contraction in the first three months of this year thanks to robust business spending.
But escalating trade frictions and a series of natural disasters that disrupted supply chains cloud the outlook for the export-reliant economy.
Japanese manufacturing activity grew at a slightly faster pace in September but business confidence fell to the lowest in nearly two years amid global trade tensions, a private survey showed on Friday.
(Additional reporting by Kaori Kaneko; Editing by Eric Meijer and Kim Coghill)