MNI INSIGHT: BOJ Blames Productivity Gain for Slow Inflation

--BOJ To Repeat Mechanism To Raise Inflation Toward 2% Target Working

By Hiroshi Inoue

     TOKYO (MNI) - The Bank of Japan is expected to blame persistent structural

factors, including productivity gains, for consumer prices' slow response to the

improving output gap and tightening labor supply, in a statement due out after

its July 30-31 policy meeting, MNI understands.

     The BOJ board is unlikely to cite any fresh factors for the slow pickup in

consumer prices and wages, but it will note that some factors that have been

already mentioned are "having a stronger impact."

     Structural issues, such as a slow rise in legally set low wages for

care-givers and daycare workers, falling rents amid the shrinking population and

depressed service prices, continue to put a lid on inflation. Stiff competition

among retailers is also keeping prices from rising steadily.

     --PRODUCTIVITY HAMPERING INFLATION

     Firms are increasing productivity to absorb higher costs through

labor-saving capital investment in robots and information technology, exerting

downward pressure on prices "more strongly" than BOJ economists expected

earlier.

     Excess workers and those in low-productivity sectors are moving to other

companies and industries, leading to higher productivity for some firms and

restricting consumer price gains, the BOJ views.

     --SLOW GAP IMPACT

     Those factors are weakening the effect of the recent improvement in the

output gap on wage and price hikes, and slow price rises are keeping inflation

expectations low.

     In May, the BOJ said, "The output gap improves in line with economic

expansion, which will raise actual prices by making firms' wage- and

price-setting stances more proactive." It added that this mechanism was still

working.

     However, the widening of the positive output gap -- tighter supply and

firmer demand -- has not led to substantial wage and price gains as the BOJ

expected a few months ago.

     In May, the BOJ also said, "As actual prices increase, firms' and

households' medium- to long-term inflation expectations rise, which will further

push up the actual inflation rate."

     However, inflation expectations haven't risen as much as the BOJ predicted

because actual price rises have been slow.

     --STUBBORN DEFLATIONARY MINDSET

     The BOJ has often blamed the stubborn deflationary mindset among households

and businesses for the slow price and wage rises. It is likely to repeat this

factor is still dominant.

     People's deflationary mindset has hampered inflation "more strongly than

expected" and people's price views have been affected by low wages in some

sectors and discounts on retail prices and mobile communications fees, the BOJ

views.

     The BOJ has been saying the momentum toward the 2% inflation target is

"maintained," citing the improving output gap, but the tightening labor supply

and production capacity haven't led to sharp wage and price gains.

     Despite the slow progress, the BOJ is expected to repeat its view that the

price momentum is "maintained."

     The BOJ has said, "In terms of the adaptive component, with the improvement

in the output gap, firms' stances are likely to gradually shift toward raising

wages and prices and the observed inflation rate is expected to rise steadily."

     --MOMENTUM STILL MAINTAINED

     The output gap continues improving in positive territory, meaning that in

theory, pressure on firms to raise retail prices is increasing and upward

pressure on consumer prices will increase with a lag of more than a few

quarters, the BOJ views.

     BOJ officials think various corporate efforts to absorb higher labor and

raw material costs will eventually hit limits but they are not sure when that

will happen.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

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