MNI INSIGHT: BOJ Sees Underlying Econ Trend Intact; Q4 A Focus

By Hiroshi Inoue

     TOKYO (MNI) - Bank of Japan officials expect domestic exports, production

and private consumption to slow somewhat in the third quarter, although

underlying trends are difficult to read, MNI understands.

     If September exports or production were weak, which wouldn't be surprising

against the backdrop of domestic natural disasters and global supply chains hit

by ongoing trade disputes, the BOJ would consider weakening the language used to

describe them.

     However, the BOJ board will likely maintain the view that Japan's overall

economy is expanding moderately when it meets Oct 30-31, as there are no signs

of a significant worsening of major economic data and the virtuous cycle from

income to spending is in tact.

     --Q4 DATA EYED

     It remains difficult for BOJ officials to distinguish the economy's

underlying trend from the recent impacts from global demand, supply restriction

and a recovery from the recent disasters.

     Although officials traditionally focus on quarter-on-quarter data to

examine the underlying trend, they will look closely at the October releases,

the first month of Q4, not only to examine the underlying trend but also to

forecast the outlook for Japan's economy.

     --SLUGGISH INFALTION RATE

     Japan's inflation rate is in an improving trend but the rate remains

sluggish as firms remain cautious about raising retail prices amid a difficult

consumer environment, the BOJ views.

     But inflation expectations are expected to pick up gradually, the BOJ

views, as firms' look to further raise wages and prices, and households'

tolerance of price rises increases with the output gap remaining positive.

     But unless households' tolerance of higher prices strengthens further amid

wage hikes, firms will not find it easy to raise retail prices.

     Some inflation measures the BOJ watches are still sluggish. The 10% trimmed

mean of total CPI that the BOJ is focused on rose 0.5% on year in August,

unchanged from July and below the recent peak of +0.8% in February and January.

     The diffusion index, showing the share of increasing items minus the share

of decreasing items, fell to 11.1 in August, down from 14.9 in July.

     --STRONG DEFLATIONARY MINDSET

     BOJ economists believe consumer prices are determined by the three factors,

the output gap, the past deflationary mindset and inflation expectations. While

encouraged by the improving output gap, they still see the impact of

deflationary mindset on consumer prices bigger than the other two factors.

     Japan's estimated positive output gap widened to 1.86 percentage points in

the April-June quarter from 1.63 percentage points in January-March, the seventh

straight quarter of the output gap being in positive territory.

     The improvement is expected to increase upward pressure on consumer prices

and inflation expectations with a lag of a few quarters.

     But inflation expectations held by firms and households haven't

accelerated, prompting the BOJ to maintain its cautious inflation view.

--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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