MNI INSIGHT: BOJ Worried Over Weaker Inflation Expectations

--Falling Inflation Expectations In 2019 Could Be Policy Debate Trigger

By Hiroshi Inoue

     TOKYO (MNI) - With consumer prices likely to be pressured lower next year

by declining crude oil prices and falling mobile phone charges, Bank of Japan

officials are concerned there may be a follow-through decline of medium- to

long-term inflation expectations, MNI understands.

     Officials believe a drop in medium- to long-term inflation expectations

will be a most troublesome factor, as in turn they will worsen the momentum

toward the 2% price target, increasing pressure on the BOJ to conduct further

easing, the BOJ views.

     Inflation expectations, along with the output gap, are seen by BOJ

officials as the vital factors in maintaining momentum toward achieving the 2%

price stability target. Although concerned over inflation expectations, they

expect the output gap to stay in positive territory -- unless Japan's economy is

hit by strong shock.

     "Weaker consumer prices to be caused by the decline in mobile phone charges

will not prompt (the BOJ) to take more easing. But the drop in inflation

expectations will be a big troublesome factor (for the BOJ)," 

     A person who is familiar with BOJ thinking said lower consumer prices from

declining phone charges will not prompt the central bank into further easing,

but declining inflation expectations will be troublesome for the BOJ. The BOJ

had to clearly indicate to financial markets that weaker consumer prices led by

mobile phone charges won't affect the assessment of the underlying trend of

inflation rate, the person added.

     The BOJ will not conduct further monetary policy immediately if medium- to

long-term inflation expectations fall. Instead, BOJ officials will initially

look to buy time, point out some brighter aspects of the inflation expectations

and stand pat, another person  familiar with BOJ thinking said. 

     Offering some balance, that person added that short-term inflation

expectations will likely be pushed up as the consumption tax hike to 10% from 8%

scheduled for October approaches.

     --LONGER EXPECTATIONS VITAL

     However, medium- to long-term inflation expectations are the most important

issue for the BOJ, he said.

     BOJ economists are analyzing whether responses to positive inflation news

are less than responses to negative inflation news. Medium- to long-term

inflation expectations don't improve with positive inflation data, but worsen

with negative inflation news.

     BOJ officials are heartened by improved corporate inflation expectations,

but they remain vigilant against the downside risk that a pick-up in observed

inflation rates will not lead improved inflation expectations.

     In the December Tankan survey, companies on average saw a slightly faster

pace of consumer price increases for one and five years ahead, compared to the

previous survey. Inflation forecasts for three years ahead were unchanged.

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

from now, up from 0.8% in September. Companies also expect a 1.2% rise five

years out vs 1.1% in September, but they expect three years ahead numbers to be

unchanged at 1.1%.

     --WEAKER OUTPUT GAP

     The output gap in the third quarter is expected to dip from 1.86 percentage

points in the second quarter as the economy contracted.

     But the output gap is expected to rise in the Q4 as the economy rebounds

after the dip in Q3 triggered by a rash of natural disasters across Japan.

--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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