MNI INSIGHT: BOJ Sees 2nd-Round Infln Impact Less Than In 2015

--BOJ To Highlight Output Gap Remains Positive

By Hiroshi Inoue

     TOKYO (MNI) - Bank of Japan officials are increasingly concerned the impact

of weaker consumer prices will weigh on inflation expectations, but they expect

the impact as smaller than that seen in 2015, MNI understands.

     The impact of the drop in crude oil prices will lower consumer prices in or

after April, which in turn will theoretically put downward pressure on inflation

expectations, known as "second-round effects,"  that BOJ economists are paying

attention to.

     The BOJ has previously said, "the adaptive mechanism has been playing a

leading role in the formation of inflation expectations in Japan."

     --LESSER IMPACT

     BOJ economists accept the adaptive mechanism persists, but with favourable

economic fundamentals they see the degree of the impact this time at a lesser

degree than in 2015, when inflation expectations had fallen in the wake of

slowing Chinese and emerging economies, along with a steep fall in crude oil

prices.

     Back then, Crude oil prices had fallen to about $30 a barrel from above

$100 the previous year, but the recent drop in crude oil price is shallower

(from $70 to $30, before recently rebounding to $50).

     --POSITIVE OUTPUT GAP

     Japan's estimated positive output gap stood at 1.24 percentage points in

the July-September quarter 2018, narrowing from 1.60 percentage points in

April-June but posting the eighth straight quarter of a positive reading.

     The positive gap is expected to increase pressure on consumer prices and

inflation expectations with a lag of a few quarters.

     In 2015, the output gap of the economy had largely been in negative

territory in both fiscal 2014 and '15. BOJ officials then expected falling crude

prices to have increased households' real income and demand and to have boosted

the economy and consumer prices.

     Consumer spending didn't, however, pick up in line with BOJ expectations,

as consumers were hit by negative factors, including slowing emerging economies,

the weak domestic economy and the negative output gap.

     BOJ officials believe the magnitude of the impact currently is smaller than

that of 2015, as the overall economic environment now is healthier.

     --TEMPORARY FALL

     The BOJ will make it clear that officials don't see a temporary drop in

medium- to long-term inflation expectations triggered by lower crude prices as

the decline of the underlying trend.

     If inflation expectations declined further than BOJ expectations, it will

be a troublesome factor, as the bank has repeatedly said that both the output

gap and inflation expectations are the crucial factors driving consumer prices. 

     But the central bank will likely -- initially at least -- play down lower

expectations, blaming temporary factors, attributing them in part to supply-side

factors, such as corporate efforts to increase productivity to absorb high

costs, which is impeding price rises.

     The board will likely argue that BOJ easy policy aimed at achieving the 2%

price target has upped corporate efforts to increase productivity, which,

ironically, is restricting price increases and i weighing on inflation

expectations. However, they will probably point to a positive output gap as of

more relevance than inflation expectations in achieving their 2% price target.

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

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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