By Leika Kihara

TOKYO (Reuters) -Japan's core consumer prices rose 3.0% in December year-on-year to mark the fastest annual pace in 16 months, likely cementing a central bank rate hike later in the day and retaining bets that borrowing costs will keep rising from ultra-low levels.

The data on Friday comes hours before the Bank of Japan concludes its two-day policy meeting, when it is expected to raise short-term interest rates to 0.5% from 0.25%.

The increase in the core consumer price index (CPI), which excludes the impact of volatile fresh food prices, matched a median market forecast and followed a 2.7% gain in November.

It was the largest year-on-year increase since a 3.1% gain marked in August 2023.

"The outcome was likely in line with the BOJ's projection," said Ryosuke Katagi, market economist at Mizuho (NYSE:) Securities. "On the price front, there's nothing getting in the way of a BOJ rate hike in January," he said.

The rise was due largely to the phase-out of government subsidies aimed at curbing utility bills, and the impact of stubbornly high food prices as the weak yen kept import costs elevated.

An index stripping away the effect of both fresh food and fuel costs, which is closely watched by the BOJ as a better gauge of price pressure driven by domestic demand, rose 2.4% in December from a year earlier, steady from November.

The BOJ ended negative interest rates in March and raised its short-term rate target to 0.25% in July on the view Japan was on track to sustainably meet the bank's 2% inflation target.

Governor Kazuo Ueda has signalled readiness to raise rates further if broadening wage hikes underpin consumption and allow companies to keep hiking prices not just for goods but services.