Japanese core consumer prices in June fell only slightly from a year earlier, as expected, but market fears about the health of U.S. credit markets raised doubts about the likelihood of a rate increase next month.
The core consumer price index (CPI), which excludes fresh foods prices, fell 0.1% from a year earlier in June, its fifth monthly drop in a row.
The CPI figure was in line with the view of the Bank of Japan (BOJ) that annual core CPI will hang around zero in the near term, but unrelated U.S. credit-market fears that sent the yen surging and stocks sliding prompted some to rethink forecasts of a Japanese interest rate hike next month.
Expectations of an increase in the central bank's key overnight call rate -- as measured by swap contracts on the rate -- fell sharply to around half.
"What worries me is the situation in the United States," said Naoki Iizuka, senior economist at Mizuho Securities. "Markets are nervous about the problem of subprime loan issues. This may become a hurdle for the BOJ's rate hike."
A selloff in credit and stock markets, as investors spooked by problems in U.S. subprime mortgages fled risk in other markets, drove the yen to three-month highs against the U.S. dollar. Japanese stocks fell more than 2%, after similar slides by U.S. stocks on Thursday.
This weighed much more on rate expectations than the soft CPI data or similarly weak retail figures also released on Friday.
Retail Sales Are Weak
Japanese retail sales fell 0.4% in June, separate data showed. The decline, blamed by officials on falling auto-sector sales for the 15th month in a row, was below economists' median forecast of a 0.6% rise.
"BOJ Governor (Toshihiko) Fukui has said they can raise rates even if the CPI remains negative," Iizuka said. "Given the figure today came in as expected, not softer than expected, I think it will not discourage the BOJ from raising rates in August," he added.
The core CPI for the Tokyo area, closely watched because it is released a month ahead of the nationwide figures, fell 0.1% in July, as expected.
Most analysts have been expecting the BOJ to raise its key overnight call rate target to 0.75% at its Aug. 22-23 meeting, up from the 0.5% level to which it raised the rate in February.
Swap contracts are now pricing in just over a 50% chance of a rate hike in August, down sharply from around 70% on Thursday.
The turbulence was now more important to expectations than the CPI figure, said Hiroshi Shiraishi, an economist at Lehman Brothers Japan. "If anything stops the BOJ, it probably has more to do with financial markets such as the correction seen overnight," he said.
Inflation In The Horizon
Core nationwide CPI has been falling since February due partly to softness in oil prices early this year.
But the rebound in oil prices since then will likely mean Japan's core CPI will post a small year-on-year rise later this year, economists say.
The BOJ has said consumer prices would likely stay mostly flat in the short term but would pick up in the long run, because underlying inflationary pressures are slowly building up in Japan due to rising resource utilization.