MNI INSIGHT: BOJ Worried But Leaves Negative Gap Alone For Now

Japan's negative output gap in the April-June quarter, the first in nearly four years and the largest in more than a decade, has the central bank increasingly worried that the inflation rate and growth expectations will will remain weak, MNI understands.

However, the Bank of Japan will not use policy tools to strengthen both indicators as its top priority is still market stability and facilitate corporate financing.

Bank officials believe the measures currently in place help avoid a negative feedback loop from unstable markets to the real economy, and prevent economic and labour market conditions from worsening.

DOWNWARD PRESSURE

The BOJ estimates the second-quarter output gap at -4.83 percentage points, a sharp reversal from the +0.14 pps in the first quarter. It is the largest negative gap since the second quarter of 2009 when it was -5.53 pps.

According to Cabinet Office estimates, which often vary from BOJ estimates, the output gap was at -10.2 pps in the second quarter, dropping for the third straight quarter and the biggest gap since 1980.

In theory, the negative gap increases downward pressure on the inflation rate with a lag of a few quarters.

DELAY

The BOJ has already said that the momentum toward achieving the 2% price target has waned for now. The bank was achieving the price target, helped by an improving output gap, which steadily pushes up wages and prices, and through actual price rises, which lift medium- to long-term inflation expectations.

The BOJ now expects the inflation rate as measured by the core consumer price index to be negative for the time being.

It will delay addressing the output gap until it needs to boost demand after the coronavirus outbreak subsides.