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Japan’s budding inflation expectations put BOJ in policy bind

THE NIKKEI via scoutAsia

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December 12, 2022 2 min read
Japan’s budding inflation expectations put BOJ in policy bind

After a decade of battling deflation, the Bank of Japan is on the brink of achieving its target of stable 2% inflation. But its task is being complicated by the government’s efforts to ease the strain on households.

The key is inflation expectations — what people expect inflation to be in the future. If more people expect prices to rise, then prices are more likely to actually rise.

For the BOJ to reach its target, it needs to tolerate the current spell of inflation in order to let inflation expectations take hold.

The government, however, has put together an economic package that aims to shave 1.2 percentage points off the inflation rate by pushing back against increases in household costs.

“We will do our best to ensure that Japanese people will benefit from our efforts, including cutting electricity prices, as soon as possible,” Prime Minister Fumio Kishida told reporters after a second supplementary budget for the current fiscal year was passed on Dec. 2.

Of the 28.9 trillion yen ($212 billion) budgeted, 6 trillion yen is for curbing gasoline prices and reducing the burden of soaring electricity and household gas rates.

On Wednesday, Japan’s 10 leading power companies said they had applied to a government program for rate decreases. In a typical case, electricity rates will return to pre-Ukraine-war levels starting in February.

Japan’s CPI rose 3.6% on the year in October — the biggest jump in more than 40 years. Signs are emerging that this historic bout of inflation is changing the long-held view of the Japanese public that prices never change.

The BOJ has crushed interest rates and increased Japan’s money supply by unprecedented amounts under Gov. Haruhiko Kuroda on the assumption that inflation will come if people expect it. This in turn will reduce interest rates in real terms without BOJ controls, encouraging companies to boost capital investment at home.

“Monetary policy will become more effective as deflationary expectations weaken,” Kuroda said when he took his position in 2013. “Working on expectations will be very important when engaging in quantitative easing and making short-term interest rates zero,” he said.

This may entail allowing the economy to overheat for a while to let inflation expectations set in. But if expectations are raised too much, with consumers feeling the heat, the BOJ could come under pressure from the government.

The central bank “is now in a difficult position to explain how it is being consistent with the government’s anti-inflation measures,” a BOJ official said.

The government’s measures may also cloud the BOJ‘s outlook. Every three months, after its monetary policy meeting, the bank presents its price outlook. The next is scheduled for January 2023.

The latest outlook does not reflect the impact of the anti-inflation measures. Should the January outlook report incorporate the 1.2-point inflation cut that the government is seeking, the price outlook for fiscal 2023 will fall short of the current forecast of 1.6% inflation.

The central bank could present multiple inflation scenarios, but this would make the outlook difficult to understand. “It’s hard to determine which measures to include and which measures not to include,” a BOJ official said.

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The English translations provided through this service are the result of automatic and mechanical translation of contents written in Japanese and created by Nikkei or licensed by a third party, by an automatic translation system provided by a third party after certain processing of the contents by Nikkei. Nikkei disclaims all warranties, express or implied, related to the English translations, including any warranty of accuracy, reliability, validity and fitness for a particular purpose. Users shall use this service with the full understanding that it employs an automatic translation system that automatically and mechanically recognizes and analyzes information and outputs the results.