MNI POLICY: BOJ Eyeing Corp Price-Setting For Deflation Signs

Bank of Japan officials are paying close attention to corporate price-setting activity for signs of a decline, which could increase pressure on the bank to take policy action, MNI understands.

It's unclear what this action might be although the BOJ has identified strengthening corporate financing and stabilizing financial markets as priorities.

If businesses lower retail prices to stimulate demand and ensure sales or profits, consumer prices as well as medium- to long-term inflation expectations would weaken, the officials warn, creating headwinds for the BOJ.

While companies have resorted to price cuts to stimulate demand during previous deflationary periods, the central bank maintains the view that current price-setting activity is solid and supportive of the BOJ's baseline scenario as the drop in consumer prices is relatively small compared with the large negative output gap.

One reason for companies to refrain from price cuts this time is social distancing, which is making it difficult for firms to increase visitor numbers and increases the risk that lower prices could lead to lower sales or profits.

DOWNWARD PRESSURE

Nevertheless, bank officials have increased their vigilance in the wake of reports at the recent quarterly branch managers' meeting.

Some managers noted corporate reports saying the response of consumers to lower prices is strengthening. One company was said to have considered price cuts, although it didn't actually do so.

The bank 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 and reflects weaker demand due to pandemic-related restrictions on economic activity.

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

The BOJ has already said that the momentum toward achieving the 2% price target has waned for now and expects the inflation rate as measured by the core consumer price index to be negative for the time being.

Bank officials have no idea when the negative output gap will move to zero or swing to positive territory.