Japan’s Inflation Momentum Wanes, Putting BOJ in a Tough Spot

Inflation in Japan rose by 0.2% in April after 0.3% in March. The CPI excluding fresh food was flat after rising 0.1% in March. The core of the CPI calculated excluding energy and fresh food was flat in April. Calculating the core excluding all food and energy leads to rise of 0.2% in April.

Inflation, broadly expressed, in April, is weak and weakening although it's not fully reflected in the sequential rates of inflation. The headline CPI rises 2.5% over 12 months, gains at a 1.1% annual rate over six months, then elevates at a 1.9% pace over three months. However, for the whole CPI excluding fresh food, there's a 2.1% gain over 12 months, a 1.1% annual rate gain over six months, and a lower 0.4% gain over three months. For all items excluding food and energy, the 12-month inflation rate is 2%, decelerating to 1.2% over six months and holding at that same pace over three months. But the core reimagined with fresh food eliminated along with energy rises by 2.4% over 12 months, at a 1.3% annual rate over six months, and eases further to a 0.8% annual rate over three months.

These progressions show the headline inflation rate roughly holds to Japan’s target of about 2% inflation. Over 12 months, the inflation rate is still too high at 2.5%; however, progressively, inflation is coming down as over three months; it holds close to the 2% target running at 1.9%. However, for the other metrics excluding food or fresh food or both fresh food as well as energy, we find inflation is decelerating more rapidly. At 12 months, all the other measures are copacetic. All the 12-month inflation rates are at or above the Bank of Japan's 2% target, but moving inside that time frame to six-months, the inflation rates are under 1 ½% and moving down to the 3-month span inflation rates are still below 1 ½% and several of the key rates are even below 1%.

These trends would seem to make it more difficult for the Bank of Japan to exercise the rate hikes that it would like to exercise to normalized monetary policy as it has been intending to do. Also, the weak yen does not yet appear to have stoked domestic inflation and the Bank of Japan has been using intervention to try to keep the yen from weakening but a more fundamental prop for the yen would be for it to raise interest rates - although the inflation statistics don't seem to allow much of that. Still, there may be a question of whether the week yen still is going to feed through into domestic inflation and provide the Bank of Japan more support for further rate hikes… so far, the data do not contain that element.

The quarter-to-date inflation data continue to show these same issues with inflation. The all-item inflation rate is at 2.3% while the inflation rates for the other metrics are below 1 ½% annualized. The quarter-to-date inflation rates are nascent calculations since April is the first month of the second quarter; starting the quarter out with such weak inflation especially with the other-than-headline measures ending the first quarter on a weak note, imparts weak momentum to inflation.

Inflation components are not supportive of the idea that inflation is going to be robust around the 2% mark. Over spans less than 12 months, there's a broad deceleration of inflation as noted by the red figures in the table. Even over 12 months, inflation has broadly decelerated from its pace of one-year ago, but still is above 2%. Over six months, inflation decelerates compared to its 12-month pace in all categories. After that, inflation accelerates in only three categories over three months compared to six months.

The Bank of Japan finds itself in somewhat difficult straits. It spent a long period of time trying to eliminate deflation from its economy, then, in the wake of COVID, inflation rose, and it looked like it might be able to hold the line on inflation especially after a strong spring wage gains were posted nationally. With the weak yen, there would seem to be another impulse of inflation on its way, but so far these two forces have failed to prop up the inflation rate. While these are two important fundamental forces pushing inflation up, Japan continues to fight against its demographic trends which show population shrinking, a factor that clearly takes pressure off inflation. As these comments illustrate, there are clear cross currents in play for Japan and it's going to be important to watch data closely. The recent PMI data suggests that Japan's economy may be picking up after a period of some lethargy. If that proves to be true, there may be more underpinning for inflation in the months ahead. As things stand now, the Bank of Japan may be looking at the ability to raise rates once but probably not much more than that and unless the inflation trends shift.