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Japan's Central Bank Surprised by Inflation, Analyst Claims

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Bank of Japan Divided Over Moves After Inflation Exceeds Target

Analysts Split on Bank of Japan's Actions

There is a division among analysts regarding the Bank of Japan's actions following the country's core inflation exceeding the central bank's target of 2% for the 15th consecutive month. CLSA Japan strategist Nicholas Smith believes that the BOJ has been caught off guard by inflation, stating that they ignored the Fed's claim that inflation was transitory. Smith argues that inflation has been above 2% for 15 consecutive months, contradicting the BOJ's forecast. Japan's core consumer price index rose 3.3% year-on-year in June, meeting economists' expectations and slightly surpassing May's 3.2% figure.

The BOJ's Monetary Policy Considerations

Core inflation in Japan excludes the prices of fresh food from the overall consumer price index. The headline inflation rate was 3.3% in June, a slight increase from May's 3.2%. The BOJ takes these inflation numbers into consideration when making monetary policy decisions, especially in anticipation of their upcoming meeting. Barclays economist Tetsufumi Yamakawa notes that the market still sees rising prices in Japan as transitory due to "cost push" factors rather than "demand pull." However, Yamakawa suggests that sustained inflation may occur due to wage hikes resulting from recent negotiations.

Possible Shift in Monetary Policy

Investors are watching closely for indications that the BOJ may change its stance on its ultra-loose monetary policy, particularly its "yield curve control" policy. This policy targets short-term interest rates at -0.1% and the 10-year government bond yield at 0.5% above or below zero, aiming to maintain a 2% inflation target. However, BOJ governor Kazuo Ueda recently stated that the ultra-loose monetary policy might be maintained as achieving the 2% inflation target is still some distance away. Analyst Nicholas Smith believes there is a high probability that the BOJ will shift its stance on YCC during the next central bank meeting.

Inflation Driven by Food, Energy, Wage Increases, and Weak Yen

Smith highlights the "core-core" inflation rate, excluding the costs of fresh food and energy, which reached 4.2% in June — the highest since September 1981. He disputes the BOJ's claims, stating that food, electricity price hikes, wage increases, and the weak yen are the main drivers of inflation. With wages experiencing the largest increase in 30 years, Smith believes that inflation in Japan will continue to surpass expectations, driven by a wage-price spiral. Failure to take action could cause the yen to rise significantly against the dollar.

The BOJ's Bond Purchases and Limits

Smith also points out that the BOJ's bond purchases have been increasing to maintain the YCC policy. Since December, bond purchases have reached 15.8% of Japan's GDP. Governor Ueda has acknowledged that the BOJ is close to its limit since it already owns a third of the bond market, which now stands at 55%. Conversely, economist Yamakawa does not anticipate a shift in monetary policy during the July meeting, but rather expects the BOJ to phase out YCC during the October meeting.

Conclusion: Impact on New Business

The ongoing division and uncertainty surrounding the Bank of Japan's response to inflation exceeding its target may have significant implications for new businesses operating in Japan. The conflicting opinions among analysts highlight the complexity of the situation and the difficulty in predicting the future direction of the central bank's monetary policy. This creates a challenging environment for businesses looking to plan their strategies and make informed decisions.

Monetary Policy Considerations

The BOJ's monetary policy decisions, particularly its ultra-loose stance and yield curve control policy, directly influence interest rates and inflation expectations. The potential shift in this policy could impact the cost of capital and borrowing for new businesses. If the BOJ decides to maintain its current policy, it may contribute to the continuation of low interest rates, supporting business investment and growth. Conversely, a shift towards tightening monetary policy could increase the cost of borrowing and impact investment decisions.

Inflationary Drivers and Wage-Price Spiral

Another critical factor for new businesses to consider is the underlying drivers of inflation in Japan. The recent increase in food and energy prices, wage hikes, and the weakening yen have contributed to rising consumer prices. If this trend continues, it could result in a wage-price spiral, where higher wages lead to increased consumer spending and further inflationary pressure. This may impact business costs, particularly in industries heavily reliant on labor and imported goods.

Bond Market and Potential Risks

The BOJ's substantial bond purchases as part of its monetary policy have already reached significant levels, and Governor Ueda has expressed concern about the limits of these purchases. This situation presents risks for new businesses that rely on healthy bond markets for financing or investment opportunities. If the BOJ reaches its limit or starts reducing bond purchases, there could be increased volatility and potentially higher borrowing costs for businesses.

Overall, the Bank of Japan's divided stance on inflation and the potential shift in its monetary policy pose uncertainty for new businesses. It will be crucial for entrepreneurs and investors to closely monitor central bank decisions and inflation trends to adjust their strategies accordingly. The impact on new businesses will depend on how the BOJ navigates these challenges and balances its goals of supporting economic growth while managing inflationary pressures.

Article First Published at: https://www.cnbc.com/2023/07/21/japans-boj-has-been-wrong-footed-on-inflation-analyst-says.html

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