MNI STATE OF PLAY: BOJ To Keep Policy Target; Weak CPI A Risk

By Hiroshi Inoue

     TOKYO (MNI) - Slow consumer price gains continue to disappoint Bank of

Japan board members and officials but the board is set to maintain its bond

yield targets this week as the momentum toward hitting the 2% inflation target,

although weak, remains intact, according to sources familiar with the BOJ's

policy-making process.

     Consumer prices remain slow to respond to the modest economic recovery as

upward pressure from the improving output gap and tight labor market conditions

hasn't grown as much as the BOJ predicted earlier.

     However, BOJ officials believe the mechanism of gradual gains in wages and

retail prices amid labor shortages and the positive output gap remains intact

and that it will strengthen.

     "Consumer prices in April and May haven't risen due mainly to temporary

factors, such as the impact of the yen's rise (that lowers import costs) and a

slower rise in mobile phone prices. But the mechanism of rising inflation

continues working," a person who is familiar with BOJ thinking said.

     The person added that the BOJ needs to examine whether the recent weak

prices have been affected by not only temporary but structural factors.

     --ECONOMY SUPPORTS PRICES

     BOJ officials expect the economy to rebound in April-June after what many

see as a temporary contraction in January-March. They also believe upward

pressure on consumer prices will pick up gradually.

     At the same time, board members will closely examine the slow response of

prices to a tighter supply of production capacity and labor at their two-day

meeting ending Friday.

     The BOJ is likely to incorporate the results of its analysis in the

medium-term growth and inflation projections in the quarterly Outlook Report due

after the July 30-31 policy meeting.

     --POSITIVE SERVICE PRICES

     BOJ officials were encouraged by the latest development in the service

producer price index, which rose 0.9% on year in April, up from +0.5% in March.

     In Japan, companies tend to revise their prices in April and October.

     SPPI showed that service prices charged to companies picked up at the start

of fiscal 2018 while CPI for April showed the pace of service price rises at the

retail level remained slow at +0.3% on year, compared to +1.3% in goods prices

excluding volatile fresh food.

     But the SPPI data still supports the BOJ view that labor shortages and

rising costs are increasing pressure on firms to raise retail prices, another

person who is familiar with BOJ thinking said.

     The person, however, noted that consumer price gains remain slow, below 1%,

as prices for durable goods haven't risen and companies remain cautious about

raising retail prices amid sluggish private consumption.

     BOJ officials are focused on the quarterly Tankan business survey due out

on July 2 to gauge how output prices have developed and higher energy costs have

hurt sentiment.

     --FLAT INFLATION EXPECTATIONS

     A third person who is also familiar with BOJ thinking said, "Short-term

inflation expectations are rising but medium- to long-term inflation

expectations -- the BOJ's main focus -- haven't risen."

     The person added that it takes more time for actual prices to rise and

influence longer-term expectations.

     The output gap has been improving but its impact on corporate price hikes

has been limited as firms are worried that higher prices will hurt sales.

     As long as the economy continues recovering, the output gap will continue

improving, which in turn should support wage and price hikes, the key step

toward higher consumer prices.

     Higher consumer prices should raise longer-term inflation expectations,

although there is uncertainty over how close the correlation is and how long it

takes for CPI to affect people's inflation outlook.

--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

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