MNI INSIGHT: Weak CPI Undermines BOJ Infl Expectations Outlook

By Hiroshi Inoue

     TOKYO (MNI) - Bank of Japan officials are annoyed at the slow improvement

in inflation expectations and believe that how the near-future rise in consumer

prices affects inflation expectations holds the key to whether the BOJ can

achieve its 2% consumer price goal sometime in fiscal 2019, MNI understands.

     If inflation expectations fail to pick up amid a further rise in consumer

prices, it would increase pressure on BOJ economists to review their previous

scenario that inflation expectations rise smoothly in response to actual

consumer prices. This, in turn, could force the BOJ to change the timing of when

it will reach the 2% CPI goal. 

     The BOJ expects Japan's core consumer price inde, excluding fresh food but

including energy prices to rise to near 1% on year, and core-core CPI excluding

both fresh food and energy items to rise to near 0.5% toward the end of this

year.

     The latest government data show that the core CPI rose 0.7% on year in

August (vs. +0.5% in July) and the core-core CPI rose 0.2% on year in August

(vs. +0.1% in July). 

     The BOJ analysis shows that Japan's inflation expectations are mainly

influenced by actual consumer price increases, known as "adaptive inflation

formation."  

     For example, in 2015, inflation expectations fell in response to the drop

in the total CPI caused by the drop in crude oil prices. BOJ analysis at that

time projected that inflation expectations should rise if total CPI were to

accelerate due to a rise in crude oil prices.

     However, in the current economic recovery, inflation expectations haven't

risen as much as BOJ economists expected based on this analysis, clouding the

outlook for the BOJ scenario for a sustained rise in inflation and inflation

expectations.

     The BOJ "didn't expect that both consumer prices and inflation expectations

would rise quickly and sharply, as it takes some time for them to rise due to

the adaptive inflation formation," a person familiar with BOJ thinking said.

     However, the person said that the improvement of inflation expectations has

remained slow and the latest survey data show that inflation expectations

reflect strongly the subdued rise in past consumer prices.

     In fact, inflation expectations by firms and households eased in the third

quarter compared with the second, according to BOJ survey data. 

     Firms on average expect the annual consumer inflation rate to stand at 0.7%

a year from now, according to the September BOJ Tankan survey, down from 0.8%

projected in the June survey. In June, they made the first upward revision in

two quarters after forecasting a 0.7% increase in March.

     Firms' inflation forecasts for three and five years ahead, on which BOJ

officials focus, were unchanged from June at 1.1% in September.

     The percentage of consumers expecting prices to rise in the next year stood

at 70.4% in September, down from 75.4% in June, according to the BOJ's consumer

survey. Looking five years ahead, 81.4% of consumers said prices would rise,

also down from 82.3% three months earlier.

     Another person familiar with BOJ thinking said that inflation expectations

are clinging to past price data more than expected. He added that inflation

expectations have stopped worsening but haven't accelerated either,  preventing

the BOJ board from changing its assessment of the inflation outlook.

     The BOJ board will likely maintain its view that "Inflation expectations

have remained in a weakening phase" at its next policy-setting meeting on Oct.

30-31.

     BOJ officials don't assess the outlook for inflation expectations through

consumer prices alone, also focusing on corporate price-setting activity and how

consumers accept higher service and goods prices.

     Businesses are exhibiting mixed price-setting behavior, with some firms

raising their prices amid higher costs but others remaining cautious about

raising prices due to strong competitive pressures.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@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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