Japan’s Inflation Remains High and Stubborn

Japan’s inflation in July continues at a pace in excess of the target sought by the Bank of Japan. However, inflation is not running wild; it's simply running hotter than the BOJ wants it to. Inflation had moved quite low in May with the headline of 0.1% and then picked up to 0.2% in June. The core rate, that had risen by 0.4% in May, slipped to a weaker rise of 0.1%. July shows the headline pace continues to accelerate with an increase of 0.4% and the core (all items excluding food & energy) logs the somewhat neutral 0.2% increase on the month.

July was an empty pinata for the hopeful On balance, the progression of inflation through July is disappointing. The monthly patterns are no longer encouraging and their progression of inflation from 12-months to 6-months to 3-months is neither disturbing nor encouraging and instead depicts an inflation rate that is wandering at a pace that's simply too high but without a clear trend. Headline inflation is up 3.2% over 12 months; that pace slips to 1.9% over 6 months but then moves back up to 2.7% over 3 months. The core pace that excludes food & energy shows the 2.6% increase over 12 months, rising to a 3.6% annual rate over 6 months, then settling back to a 2.8% annual rate over 3 months. While the core rate decelerates from 6-months to 3-months, the 3-months the rate is still above the 12-month pace which is not the signal that the Bank of Japan is looking for from the inflation rate.

Monthly inflation patterns If we rummage through the details of monthly inflation by industry, in July there are strong gains in reading and recreation as prices rose by 1.5%; also, for food and beverages as prices rose 0.8%; for clothing and personal items prices rose by 0.5%. In June there are not as many pressures present, but the largest month-to-month gain in these major categories is 0.3%. Categories with the max gain include food & beverages, clothing & personal items, and the miscellaneous category. Meanwhile, housing costs were flat in June as reading & recreational prices slipped by 0.2% month-to-month. In May when headline inflation was so low, four categories had increases of 0.4%; those were food & beverages, medical care, reading & recreation, as well as transportation & communication.

Longer inflation patterns Looking at these industry patterns, sequentially there's scant evidence of categories with inflation accelerating or decelerating for the most part inflation is just gyrating. Inflation changes look more chaotic or somewhat random. Over 3 months inflation decelerates for food & beverages, for educational costs, for medical care, for reading & recreation, and for transportation & communication. There are two decelerations in a row only for food & beverage prices that slip from an 8.7% gain over 12 months to an 8.6% gain annualized over 6 months, to a 6.2% annual rate over 3 months. That's the only category that shows clear directional progress; it's also the category with the hottest 3-month inflation growth rate.

Inflation steps into a new quarter With the July report, we're one month into a new quarter and looking at the rise in inflation in July relative to the previous quarterly average. The quarter-to-date headline inflation at 3.3% with core inflation running at a 2.4% annual rate, finds inflation is excessive for food & beverages at 7% in the quarter, clothing and personal items inflation is at 4.4%, reading & recreation prices are up at a 9.4% annual rate, while transportation & communication prices are up to a 3.6% annual rate. However, housing prices, education, medical care, and miscellaneous items are all running inflation rates in the one to 1 ½ percent range, quite subdued.

Summing up Quarter-to-date and year-over-year inflation across categories shows a pace hotter than the respective five-year averages, line item by line item. Japan went through a long period of fighting off deflation; the five-year average for the headline inflation rate is 1%, the five-year average for the core inflation rate is 0.2%. The Bank of Japan is not looking to get back to those standards; it's looking to get inflation back to 2% which is its target. So, this is the complication for the BOJ; it is to some extent happy with the presence of inflation and the appearance that the deflation psychology in Japan has been broken. But that doesn't make it happy with excess inflation.

The BOJ very much wants to slip inflation back to its targeted pace. And for the time being, we can argue that it's close to doing that with 12-month headline inflation at 3.2% - well above the 2% target. However, the core rate at 2.6% is much closer. Over three months headline inflation at 2.7% is not that far from a 2% target. Over three months core inflation is at 2.8%; that’s somewhat worse than its year-over-year pace. These numbers suggest the Bank of Japan has more work to do in terms of getting inflation back in place, but the BOJ is much more involved in a process that looks more like fine tuning rather than the U.S., the European Monetary Union or the U.K., where they continue to have an inflation rates running well above their targets and they have a substantial task of inflation reduction ahead of them. When it comes to inflation, Japan may have some for the first time in a long time, and a real inflation problem. However, as these problems go, Japan has a minor league dilemma compared to its fellow money-center central banks and their much more serious current challenges.