Japan’s Core CPI Puts Bank of Japan in a Tough Spot Again

After release of Japan's headline report for the CPI for May, it appeared that the way had been made clear for the Bank of Japan to begin to raise rates and began to move interest rates into more sustainable, neutral, long-term territory. A rate hike could also go some way toward helping to support the yen that has been struggling. Headline inflation in Japan is at 2.9%; while it dipped to a 2.1% pace over six months, it's running at a 3.8% annual rate over three months.

However, new data on the core suggested Japanese inflation is running substantially weaker than headline inflation suggests. The generic all items excluding food and energy metric was flat in May, up by 1.6% over 12 months, up by 1.2% at an annual rate over six months, and up at only a 0.8% annual rate over three months. Core inflation shows that inflation pressures are not broadly shared. The statistic for all items except fresh food and energy rose by 0.1% in May, and has a stronger 2.1% gain over 12 months, quite close to the Bank of Japan target. However, over six months, this core metric is up but only a 1.3% annual rate; over three months, it's up at only a 0.4% annual rate. Neither of the measures of the core inflation rate shows that there's much inflation stirring in the Japanese economy. They are far from giving the BOJ an ‘all clear’ signal for any kind of rate hiking. Their sequential progression to lower inflation rates over the past year underscore ongoing price weakness.

These are data through May so two-thirds of the monthly data are now in hand. Quarter-to-date all item inflation is rising at a 2.9% annual rate; inflation for all items except food and energy is up at just a 0.9% annual rate; and for all items except fresh food and energy, the rate of increase in the quarter-to-date is only 0.5% at an annual rate.

The quarter-to-date data for all items except fresh food and energy comes in very close to the five-year average for that series which showed an average annual increase of 0.6% per year. For all items ex food and energy, the gain of 0.9% in the quarter-to-date is higher than the 0.6% it averaged over five years. However, headline inflation of 2.9% quarter-to-date is up considerably more strongly than the five-year average pace of 1.4%.

Progressive inflation by industry The details of Japan's inflation based on the 8 categories in the table show that inflation over the past year compared to the year before that is lower in all categories except for reading and recreation. The inflation rate across categories over six months shows a step down in the pace of inflation for all categories compared to the pace they set over 12 months. The pace of inflation over three months shows a step down on the pace of inflation for five of the 8 categories with the acceleration showing up in food and beverages, the miscellaneous category, as well as transportation & communication.

In addition, over three months prices are falling for clothing and personal services as well as for education and in medical care. The decline in prices in the educational category is persistent as it shows prices declining - and declining at a progressively faster pace - over 12 months, six months, and three months. No other category shows persistent price weakness like that; in fact, no other category shows prices falling over 12 months or six months.

This report that is fully fleshed out for May does create some policy dilemmas for the Bank of Japan if it's seeking to normalize interest rates any time soon. While the headline inflation rate would seem to justify a rate hike, the core rate, and the breadth of inflation across categories does not seem to be in sync with the central bank raising rates. Headline inflation is running higher than target; in fact, it's accelerating from 2.9% over 12 months to a 3.8% annual rate over three months. But the core inflation rates are below the Bank of Japan's 2% target with progressively weaker results in train over six months and three months. These trends will complicate monetary policy if they remain in force in the months ahead.