MNI INSIGHT: BOJ Confounded By Stubborn Deflationary Mindset

--BOJ Uncertain What To Do to Boost Inflation Expectations In Short Run

--BOJ Believes Corporations Will Hit Limit and Be Forced to Raise Wages, Prices

--But BOJ Can't Say When That Limit Will Be Reached 

By Hiroshi Inoue

     TOKYO (MNI) - Bank of Japan officials have had a rude awakening at how

deeply-rooted the deflationary mindset in Japan is, how little it has improved

and how it still dominates thinking in many boardrooms when it comes to setting

retail prices and wages, MNI understands.

     In general, companies remain cautious about raising fixed labor costs and

marking up sales prices in the face of uncertainty over global and domestic

demand. This has caused consumer price increases to lag behind BOJ expectations

despite Japan's modest but sustained economic recovery.

     To divert market and public attention from the problem, BOJ officials have

been attributing the slow improvement in pricing sentiment to firms investing in

labor-saving equipment and streamlining operations to absorb higher labor costs.

But what is left unsaid is the belief that their policy efforts are being

hamstrung by the nation's deeply-ingrained deflationary attitude.

     BOJ officials believe that the mindset will gradually erode over time as

the economic recovery continues, the labor market tightens further and costs

continue to rise. But they are flummoxed about what to do about weak inflation

expectations in the near term.

     The BOJ has long argued that inflation expectations react to changes in

actual inflation, known as "the adaptive expectation formation."

     For instance, the BOJ argued that the drop in inflation expectations in

2015 was due mainly to the weakness in consumer prices caused by the plunge in

energy costs at that time. The central bank said if total CPI were to rise, it

would boost inflation expectations.

     But that mechanism is not working at the moment.

     Japan's total CPI rose 0.7% on year in September, with the pace of increase

accelerating from +0.4% in January and -0.5% in September 2016. However, surveys

show that the recent slight improvement in inflation expectations has stalled.

     Publicly, the BOJ continues to assert that labor-saving business investment

and reorganization of operations will increase productivity and Japan's

potential growth rate, which will eventually generate an environment for raising

wages at a faster pace.

     Privately, BOJ officials believe that these corporate efforts to avoid

rising wages and prices will eventually hit a wall. However, BOJ officials

cannot predict when that limit will be reached.

     If firms had greater confidence in growth prospects, more would raise wages

to secure necessary workers and hike retail prices to reflect higher costs,

instead of seeking ways to make their operations more efficient and suppress

labor costs, BOJ officials believe.

     BOJ officials expect that global growth will continue to strengthen,

boosting Japanese exports and so domestic growth. This, in turn, will change the

corporate mindset, they hope.

--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

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

[TOPICS: MMJBJI,MMJBJ$,M$A$$$,M$J$$$,MT$$$$,MX$$$$]