MNI INSIGHT: BOJ's CPI View Drifting Lower Amid Mixed Signals

By Hiroshi Inoue

     TOKYO (MNI) - Bank of Japan officials believe the path toward 2% inflation

remains intact despite the slow pickup in consumer prices and even if there is a

slight downward revision to the BOJ board's CPI forecast for fiscal 2017 in its

quarterly Outlook Report in October, MNI understands.

     BOJ officials are heartened by faint but encouraging signs on the outlook

for consumer prices but they are not confident that the pace of price rises will

accelerate as much as they want in the very near term.

     While some firms are raising prices to cope with labor shortages, others

are cutting retail prices in order to lure customers. Inflation expectations

among households and businesses remain weak as the pace of wage hikes for

regular workers has been very slow. In addition, the higher import prices

resulting from the past depreciation of the yen have not translated into

widespread increases in prices at the consumer level.

     The pace of consumer inflation is unlikely to accelerate very much, which

in turn would prompt the BOJ board to revise down its median forecast for the

core CPI (excluding fresh food) for the current fiscal year from the 1.1% rate

projected in July when it updates its three-year projections at its Oct. 30-31

meeting. The July forecast was lowered from the 1.4% rate projected in April.

     "Consumer prices are deviating below the forecast [made in July], casting

doubt on the 1.1% rate forecast," said a person familiar with BOJ thinking.

     However, the person added that BOJ board members will update their price

outlook after digesting CPI and household spending for August, due on Sept. 29,

as well as inflation expectations included in quarterly surveys for September,

due in October.

     CPI for September will be released on Oct. 27, and other key September

data, such as household spending, jobs and industrial production, will be

released on Oct. 31, the second and final day of the BOJ meeting for the month.

BOJ board members discuss economic and financial conditions on the first day and

focus their debate on monetary policy on the second day, although they pay

attention to key data being released in the morning of the second day.

     From a longer-term policymaking viewpoint, weaker inflation figures would

not prompt the BOJ to consider increasing monetary stimulus. BOJ officials

believe the momentum toward achieving the 2% inflation target has been

maintained and the underlying price trend is improving, albeit at a very slow

pace.

     A slight downward revision to the bank's inflation outlook for the current

fiscal year ending next March would not affect the board's price outlook for

fiscal 2019 because it is hard to accurately forecast the output gap (a wider

positive gap supports higher prices) and inflation expectations so far in

advance.

     Downward pressure from the slower-than-expected pickup in prices on the

board's median forecast for inflation in the current fiscal year may be eased

slightly by the departure in July of the last skeptics of the effects of

aggressive easing, Takehiro Sato and Takahide Kiuchi, both former private-sector

economists who continued to predict that 2% inflation would not be achieved

within the projection period at the time. They often said their CPI forecasts

were lower than other board members.

     This is because forecasts for the majority of the nine policy board members

exclude the highest and lowest figures. In the previous Outlook Report in July,

the lowest figures indicated in charts for core CPI in fiscal 2017 were +0.4%

and +0.5%, which appeared to be projected by Sato and Kiuchi, against the median

forecast for +1.1% and the highest forecast of +1.4%. The report said the

forecast range of the majority of the board was from +0.5% to +1.3%

     At the same time, it remains uncertain what forecasts the new board members

Hitoshi Suzuki, who was an executive at the Bank of Tokyo-Mitsubishi UFJ, and

Goushi Kataoka, a former economist at Mitsubishi UFJ Research and Consulting,

will make, except that their inflation views are expected to be more positive

than those held by Sato and Kiuchi.

     Suzuki and Kataoka joined the BOJ board on July 24 but they will

participate in their first policy meeting on Sept. 20-21. Kataoka is believed to

be sympathetic to the reflationary policy stance of Governor Haruhiko Kuroda,

and Suzuki is also expected to follow the governor's lead.

     Government data show that the national average core CPI (excluding fresh

food but including energy prices) rose 0.5% on year in July, the seventh

straight year-on-year rise, after +0.4% in June. The key indicator of inflation

posted the first rise in 13 months in January.

     Excluding the upward pressure from energy prices, the underlying price

trend has shown a slower improvement. The CPI excluding fresh food and energy

(the core-core CPI) rose 0.1% on year in July, after being flat in the previous

three months and falling 0.1% in March.

     Both the core CPI and core-core CPI figures have been somewhat weaker than

the BOJ board predicted at its July meeting, when data up to May were available.

     On the slightly brighter side, the central Tokyo core CPI, which tends to

be a leading indicator of the national average, rose 0.4% on year in August,

with the pace of year-on-year increase rising from +0.2% in July.

     This suggests the national core CPI for August due out on Sept. 29 is

expected to rise by at least 0.6% on year, up from +0.5% in July.

     In the BOJ's estimate, the 10% trimmed mean of the total CPI rose 0.4% on

year in July after +0.3% in June.

     Figures are the weighted averages of the year-on-year price changes in

individual items making up the CPI. Items are arranged in ascending order of

their year-on-year rate of price change, and those falling into the upper and

lower 10% tails by weight are trimmed.

     The trimmed average is widely regarded as the key indicator to assess the

underlying price trend at the BOJ, said another person familiar with BOJ

thinking.

     Among other BOJ estimates, the diffusion index (DI) -- showing the share of

increasing items minus the share of decreasing items in the core CPI basket of

goods and services -- rose to 21.8 in July from 18.9 in June, for the first rise

since March.

     BOJ economists are analyzing that the recent gains in the trimmed average

and the DI reflected a more positive move among firms to raise retail prices as

well as upward pressure on durable goods from the past depreciation of the yen.

     In preparing materials for the board's inflation forecasts, BOJ economists

are focused on both the output gap and inflation expectations.

     The BOJ estimates the country's output gap to be +0.79% in the

January-March quarter, the third straight positive figure following +0.57% in

the final quarter of 2016 and +0.07% in the third quarter. The estimate for

April-June this year will become available on Oct. 4.

     The improvement in the output gap is expected to increase the upward

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

quarters.

     BOJ officials are keeping a close eye on how a continued modest economic

expansion, resilience of private consumption and a tight labor supply will have

a positive impact on consumer prices.

     They are also paying attention to whether inflation expectations among

companies will continue improving from the three months before.

     If improvement in corporate inflation expectations is confirmed in the

September Tankan survey due out on Oct. 2, it would prompt the board to upgrade

its assessment of inflation expectations, which says they "have remained a

weakening phase."

     In the June Tankan survey, firms on average expected the annual consumer

inflation rate at 0.8% a year from now, up from 0.7% in March. It was the first

time in two quarters that they had revised up their outlook.

     Companies expect a 1.1% rise three years ahead, up from 1.0% previously. It

was the first upward revision since the BOJ began releasing the price outlook

data as part of the Tankan. Firm's inflation forecast for five years ahead was

unchanged at 1.1%.

     However, inflation expectations among companies haven't picked up as much

as BOJ economists expected.

     The BOJ expected inflation expectations, which had been dampened by lower

crude oil prices in the past, to have risen more due to a rebound in energy

costs.

     The total CPI gained 0.4% on year in July, posting the 10th straight

year-on-year rise, but the pace of increase remained at 0.4% as seen in the

previous three months.

     The base-year effect of higher energy prices on the CPI is expected to peak

around October and fade gradually afterward, restricting the rise in the total

CPI.

--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

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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