Inflation may perk up in Japan, but not the kind of higher prices wanted

Pedestrians cross a road in front of the Bank of Japan headquarters in Tokyo, Japan on Sept. 21, 2016.
Kiyoshi Ota | Bloomberg | Getty Images

Just when the Bank of Japan might have been expected to crow that price rises are finally heading towards its elusive target, insiders are fretting that it's not the kind of inflation they ordered.

With oil prices slowly recovering from a crash in 2015 and the yen weak after plunging from mid-November, a growing number of analysts agree that inflation will reach around 1 percent or more later this year.

That should be good news for the BOJ, which in an effort to end decades of deflation has spent four years printing trillions of yen in new money and a year ago set negative interest rates, only to see inflation stick stubbornly around zero.

Far from it, say sources familiar with the central bank's thinking.

"The key is whether price rises will accelerate backed by strength in the economy. That's not clear," said one of the sources.

The central bank would much prefer that inflation was a product of improving economic activity or consumer sentiment, rather than external factors like oil and currency moves.

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"Prices will rise, but not for the right reasons," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute.

And if inflation is to encourage consumers to spend sooner rather than later, it would help if their capacity to spend grows, too, but employers are showing no inclination to raise wages.

"There's uncertainty on the outlook, particularly for wages," said another of the sources.

BOJ Governor Haruhiko Kuroda, in concert with Prime Minister Shinzo Abe, has been urging firms to boost wages for years, with little success.

In a Reuters poll of 531 companies this month, nearly two-thirds said they had no plans to raise workers' wages this year.

The BOJ is also wary of fuelling market speculation of an early withdrawal of its monetary stimulus measures by sounding too optimistic on prospects for achieving its 2 percent inflation goal, the sources said.

Such speculation could spike bond yields and force the BOJ to actually step up its massive bond buying to keep yields in line with its targets.

So it will maintain or only slightly raise its inflation forecasts at next week's quarterly projection review, they said.

Managing expectations

Before the recent yen fall, there was little to be optimistic about.

Core consumer inflation declined for the ninth consecutive month in November, and in Tokyo recorded the biggest fall in nearly four years in December.

Japanese consumers could finally spend more, analyst says

"The weakness may be a sign companies are still cautious of raising prices," said a third of the sources.

That caution is in part a product of their experience in 2015, when price rises led to falling sales.

Fast Retailing, owner of Uniqlo brand clothing, reversed price rises last year after they turned consumers away.

So though analysts now think core consumer inflation will rebound in February and reach 1 percent around mid-year, BOJ officials fear such gains, mostly due to higher imported grocery costs, will kill any recovery in consumption.

The BOJ's current estimate is for core consumer inflation to hit 1.5 percent in the fiscal year beginning in April and 1.7 percent the following year, but those estimates, considered overambitious by most analysts, were made in November, before the yen took a tumble from about 102 to the dollar to a trough of more than 118 in early January.

In next week's review, if the BOJ factors in its estimate that a 10 percent fall in the yen would add 0.3 percentage point to inflation in a year, that could push next fiscal year's forecast to around 1.8 percent.

That is still more ambitious than private forecasts of 0.8 percent but could encourage markets to contemplate prospects for a near-term rate hike.

About 40 percent of analysts polled by Reuters this month already expect the BOJ's next move will begin the retreat from its very loose monetary policy, up from 32 percent in December.

So BOJ officials say any upgrade in its price projections next week won't be that big.

Some central bankers are indeed warming to the idea of raising the BOJ's yield curve targets if rising inflation reflects a solid expansion in the economy.

But many of them say there should be no debate of a rate hike until there are clear signs the economy is strong enough to generate sustained wage growth, the sources say.

Till then, the BOJ aims to puncture such speculation, even if it means playing down factors that might boost inflationary expectations.

"There needs to be a general mood among the public that conditions for normalizing policy are falling into place," one of the sources said. "That could take a very long time."

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