Does Japan’s CPI Pave the Way for Opportunistic Normalization?

Japan’s core CPI – the CPI excluding fresh food and energy- rose by 0.2% in September as the headline rate fell by 0.4% - both month-to-month. The measure of all items excluding food and energy rose by 0.1%; prices excluding only fresh food fell by 0.3%.

Year-on-year inflation trends Year-on-year inflation was excessive for the headline at 2.4%, but that was a down-draft from a year-on-year pace of 3.1% from a month-ago. Core inflation settled to target on a 12-month basis as the pace dropped to 2.0% from 2.1% a month ago. Prices less fresh food fell to a 2.4% pace over 12 months from a 2.8% pace a month ago. Prices excluding all food and energy logged a 12-month gain of 1.7%, the same as a month ago. Not surprisingly, different measures show different trends. The headline is a bit hot but the preferred core measure, excluding only fresh food and energy, shows inflation dead-on target. Still, that is not the end of the story.

Inflation risk rises in the core The X-fresh food and energy core (xFFE) is spot-on over 12 months, but that may be a passing fancy. Sequential growth rates for this measure show the xFFE core running at a 2.3% clip over six months and by 3.0% at an annual rate over three months. Inflation may only be transitorily at its 2% target as it builds a head of steam for stronger expansion that, if sustained, would push the core beyond 2%.

The BOJ’s policy hurdles The Bank of Japan is trying to corral inflation and herd it to its 2% target amid difficult circumstances. Like the rest of the world, COVID hit Japan hard. But Japan also has been in a long slog trying to raise inflation from undershooting after a substantial period of undershooting. This accomplishment may seem like nothing more than textbook central banking. But it occurred in an environment in which Japan’s population is shrinking and as Japan also has faced several severe shocks including a tsunami that triggered a nuclear accident. None of that is garden variety central banking.

Japan closes in on policy success Japan finds its well distanced from those past issues in policy if not in time. Inflation, by various measures, seems more like it is swarming at or around the 2% target - a sign of more substantial progress. But the BOJ is most interested in its headline and in the Fresh food and ex-energy core. That duo currently casts a dilemma for policy. Headline inflation is excessive but has been cooling as its 3-month pace shows that cooling continues. But the x-fresh food and energy metric that is spot-on-target over 12 months also is moving and its momentum is up and as high as a 3% pace over 3 months.

BOJ quandary – a way out This divergence leaves the BOJ in a quandary. It is not so far from achieving its goals that it could not just wait things out. The headline vs. core divergence is there but is not severe- it may be a bit uncomfortable but it’s not policy rift. And since the BOJ still has interest rates low and has been seeking an opportunity to normalize rates, the thing to do is probably to pay attention to the core inflation dynamic and raise the policy interest rate to bring core inflation back to heel. The core acceleration would seem to give the BOJ the opportunity it seeks to continue its move to policy normalization without risking economic growth.

Enough economic strength to absorb a rate hike Japan’s PMIs show readings hovering just above the 50 breakeven mark for growth. The service sector shows more strength than manufacturing – manufacturing has a reading that is just a few ticks below breakeven. Still the ranking of these observations over the last four and one-half years shows the composite PMI and the services PMI with standings in their top-ten percentiles! Manufacturing ranks lower but is still solid at the two-third mark for its historic 4 ½ year ranking. Japan’s Tankan report has echoed these signals with a similarly solid view of manufacturing for large firms and an extremely strong reading for large nonmanufacturing firms. The economy seems to be primed for the BOJ to take the next steps.

No pressing need but a step toward a sought objective is within reach Nothing on the policy front is pressing and even the yen has begun to gain back some lost ground to help continue inflation. Still, monetary policy is often about opportunity. While central banks are ‘all-powerful’ and can do as they choose, they prefer to make policy moves that seem to come out of the flow of need or to a clear transition toward a known goal. Years ago, in the U.S., Alan Greenspan coined the phrase ‘opportunistic disinflation’ as his policy to get inflation lower, as it was dropping without much Fed action. This year, in the U.S., Chair Powell seems to have hurried a rate cut to start a process already followed by many other global central banks to get the U.S. on the same rate-cut cycle, even though U.S. data have been unclear on the need to cut rates. U.S. circumstances accommodated a cut more than demanded it. Central banks like to change rates when their actions need less rather than more explanation. The Bank of Japan seems to be offered such an opportunity now, for ‘opportunistic normalization.’