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Is the Bank of Japan’s inflation target realistic?

Inflation growth has proven to be an elusive creature in the year of 2017, puzzling central bankers and the market alike. 

Japan Flag
Source: Bloomberg

Among the lot, Japan remains as one of the developed economies facing the greatest gap from their inflation target of 2%, having to delay the window for achieving the target for the sixth time in July last year. Japan’s headline consumer price index (CPI) growth averaged just 0.4% in year-on-year (YoY) terms for the first eleven months of 2017, compared to benchmarks including US’s core CPI average at 1.8% core CPI and Europe’s HICP inflation of 1.6%.

Elusive prices

Since establishing the ‘price stability target’ of 2% in 2013, the inflation rate has dipped briefly to the depths of -0.5% in 2016 and shown slow progress towards the BoJ’s goal despite improving economic growth. This had invited doubts over the feasibility of the target, particularly for the Japanese economy that is characterised by low economic and productivity growth.

Around the globe, prices have to a large extent been whipsawed by the movements in energy prices and the subdued trend through 2017 certainly proved a hurdle for price inflation to accelerate. Over and above the oil factor, Japan continues to face a cultural lack of wage inflation, seeing wages post their first gain in 11 months only in November. Hopes for a softer yen to bring in inflation in late 2016 have also been quickly dashed. Some solace may be on the horizon as corporates look increasingly accepting towards raising wages in the upcoming spring negotiations. Meanwhile, labour market reforms, expanding the workforce with women and elderly participation, are also expected to boost spending and prices. 

Inflation and markets

As San Francisco Fed President John Williams’s speech in Phoenix, Arizona last November highlighted, most Americans are not keen to ‘see prices rise rapidly’, but it holds vastly different meanings for the market. The direct impact of inflation on markets will be via monetary policy as the BoJ conducts their policy with the aim of ‘achieving price stability’ and judges the 2% target to be one consistent with the desirable result. In the pursuit of the central bank’s goals, the BoJ currently maintains a negative interest rate policy (NIRP) and long-end yield curve control.

While the path towards the BoJ’s target looks fraught with difficulty, the BoJ certainly showed little intentions to abandon the target despite calls. One former BoJ board member, Sayuri Shirai, had recommended more flexible approaches towards the price target, though the implementation may easily be perceived as a step towards exiting its ultra-loose monetary policy. This in turns send tremors through markets, as foretold by last November’s misreading of BoJ Governor Haruhiko Kuroda’s comments.

For the time being, the BoJ may be trapped between a rock and a hard place. The expectation for global price inflation to see higher levels in 2018 potentially provide some consolation for the BoJ eyeing the 2% target and for the most relevant market, the USD/JPY trade, both inflation progress and the BoJ’s guidance remain pinnacle. 

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