MNI INSIGHT: BOJ To Review Price Mechanism Amid Flat Outlook

--Longer-Term Inflation Expectations Unchanged For Over A Year

By Hiroshi Inoue

     TOKYO (MNI) - Japan's longer-term inflation expectations haven't moved up

for more than a year as the pace of consumer price increase has slowed amid a

modest economic recovery, prompting Bank of Japan economists to review their

theory that firmer growth will produce upward pressure on prices, MNI

understands.

     BOJ officials are fully aware that inflation expectations will not pick up

anytime soon in the face of the stubborn deflationary mindset among companies

and households, but the stagnant price move and the slow pickup in the inflation

outlook are worse than expected.

     --REVIEW OF MOMENTUM

     The BOJ board is expected to maintain its view that "inflation expectations

have been more or less unchanged," a statement unchanged since January.

     Despite the continued slow pickup in actual prices and inflation

expectations, the BOJ board has been saying the momentum toward achieving the

bank's 2% inflation target is "maintained."

     BOJ officials understand this statement is "too vague" and "does not

explain the situation well," which is why they will try to present after the

July 30-31 meeting a detailed review of the growth-price transmission mechanism

and the effectiveness of the yield curve control easing policy framework in

place since September 2016.

     --FLAT LONG-TERM EXPECTATIONS

     Firms on average expect the annual consumer inflation rate at 0.9% a year

from now, up from 0.8% in March. But companies expect a 1.1% rise for both three

and five years ahead, unchanged from March. The three-year projection has been

unchanged for five quarters and the five-year forecast for seven quarters.

     This follows the main Tankan results released Monday that showed a slight

worsening of business sentiment, hit by rising costs, labor shortages and

uncertainty over the impact of U.S. trade disputes on global demand.

     BOJ economists are trying to figure out why prices are slow to respond to

an improvement in the output gap and a tightening labor supply.

     The BOJ has been saying that firms' stances will "gradually shift toward

raising wages and prices with the improvement in the output gap and as inflation

expectations gradually rise."

     However, inflation expectations haven't gained upward momentum because

wages and retail prices haven't risen as much as the BOJ expected despite the

positive output gap in the economy has continued for over a year.

     The underlying inflation rate measured by the core-core CPI (excluding

fresh food and energy) rose 0.3% on year in May, slowing from +0.4% in April.

     --OUTPUT VS PRICES

     The BOJ estimates the positive output gap resulting from tighter supply and

firmer demand widened to 1.50 percentage points in the October-December quarter

of 2017 from 1.14% points in July-September (Q1 2018 data due out Wednesday).

     It was the fifth straight quarter of the gap being in positive territory.

     The improvement in the output gap is supposed to increase upward pressure

on consumer prices and inflation expectations with a lag of a few quarters, but

there is no clear sign that it is happening.

     In its quarterly Outlook Report in April, the BOJ said that "the rate of

increase in prices of goods that are responsible to economic activity, including

food products and goods related to daily necessities, is expected to accelerate

gradually with a moderate increase in private consumption."

     However, the prices for processed food (canned food, bread, snacks,

beverages, etc.), which accounts for about 15% of the total CPI, hasn't risen as

much as BOJ officials expected. The index rose 0.9% on year in May, slowing from

+1.0% in April and in March and +1.2% in February.

--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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