REPEAT:BOJ STATE OF PLAY:Upbeat 2017 Start, Challenges Remain

Repeats Story Initially Transmitted at 07:33 GMT Jan 5/02:33 EST Jan 5

By Max Sato

     TOKYO (MNI) - For the Bank of Japan, the new year started with a slightly

brighter tone on the economic activity and sentiment fronts, but the road to

stable 2% inflation remains bumpy.

     The New Year began with a sharp gain in the Tokyo stock market, the

lifeline for Prime Minister Shinzo Abe's inflationary policy mix that relies

heavily on large-scale monetary easing amid limited fiscal spending and the slow

progress in structural reforms and innovative investments.

     With the stock markets rising and the yen remaining relatively weak,

business and consumer sentiment have improved. Job offers have been rising and

part-time wages have been growing as firms are trying to cope with increasing

labor shortages.

     --LABOR SHORTAGE CONCERNS

     The Economy Watchers Survey sentiment index for Japan's current economic

climate in November rose 2.9 points to 55.1 from 52.2 in October, posting the

third straight month-on-month rise on firmer stock prices.

     However, the outlook index on sentiment over the next two to three months

fell 1.1 points to 53.8 in November from 54.9 in October, marking the first drop

in two months. Some firms reported that higher fuel, material and labor costs

were squeezing their profits. Others complained that labor shortages were

forcing them to decline orders.

     The outcome of the Watchers Survey for December conducted from Dec. 25 to

Dec. 31 is due on Jan. 12.

     Data released late last month showed industrial output rose for the second

straight month while both retail sales and household spending rebounded. The

data indicated Japan's modest but sustained economic recovery will continue for

now, with the annual GDP growth rate hovering just above the economy's growth

potential estimated somewhere between 0.5% and 1%.

     The latest median forecast for Japan's GDP growth by the nine-member BOJ

policy board is 1.9% for the current fiscal year ending in March before slowing

to 1.4% in fiscal 2018 and 0.7% in fiscal 2019. The board will update its

projections at its next meeting on Jan. 22-23.

     --SALES TAX HIKE SCARE

     The government plan to implement the second stage of the doubling of the

sales tax rate to 10%, which had been postponed twice by Prime Minister Abe in

political decisions before he called snap elections, comes at a sensitive timing

for BOJ policymakers, the majority of whom still believe the bank can achieve

its 2% inflation target "around" fiscal 2019.

     If the sales tax is raised to 10% from the current 8% in October 2019, as

now planned, consumption is expected to show a large swing, with durable goods

spending rising fast in the first half of fiscal 2019 for the tax hike takes

effect and slumping in the second half.

     The hike from 5% to 8% in April 2014, which was the first increase in sales

tax in 17 years, caused a plunge in consumption for a longer period than

anticipated by government and central bank officials amid slow wage growth. That

has made retailers even more cautious about raising prices and firms are still

reluctant to offer large increases in base wages.

     The downdraft from the tax hike this time, which may be less damaging than

in 2014 due to a slightly smaller increase, is still expected by BOJ officials

to hit the economy and so could be a setback for the bank's struggle to lift low

inflation toward its elusive 2% target. The BOJ board now projects an average

core CPI rate of 1.4% in fiscal 2018, while many private-sector economists see a

lower rate of around 1%.

     --COUNTING ON WAGE HIKES

     A slight pickup in the consumer price index released on Dec. 26 is the last

piece of CPI data before the BOJ meeting this month.

     At this point, there is no hard data to suggest that the board should lower

its core CPI forecasts again in January after revising its median forecast for

fiscal 2017 down to +0.8% in October from the +1.1% rate projected in July and

the one for fiscal 2018 down to +1.4% from +1.5%.

     The national average core CPI (excluding fresh food) rose 0.9% on year in

November, the 11th straight year-on-year rise, with the pace of increase

accelerating from +0.8% in October.

     Goods prices are up on higher import and labor costs while service prices

were flat, as many firms continue to resist price hikes amid tough competition,

absorbing higher materials and labor costs by investing in technology and

curtailing business hours.

     But BOJ officials hope the pickup in the CPI, although slow, helps support

the move by some firms to raise wages for fiscal 2018 during annual

labor-management negotiations to be held in coming weeks. Some economists are

skeptical of any major increase, however, predicting firms will generally remain

cautious.

     Because wage increases are usually based on actual inflation the year

before, the BOJ remains hopeful that the higher inflation will trigger a rise in

base wages.

     The weak wage hikes agreed in April 2017 were based on weak consumer prices

in calendar 2016, when the consumer price index fell 0.1% on average. By

contrast, total CPI rose 0.4% on average in the first 11 months of 2017.

     In theory, higher income supports higher consumer spending but many

households remain cautious in their buying habits amid concerns about the

sustainability of government social security and future salary levels.

--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