- Date:
- Author:
- Sam Jochim
The recent burst of inflation in the US and in many other countries has led investors to wonder whether the entire inflation environment has changed.
The Bank of Japan (BoJ) made no changes to interest rates at its meeting in April but announced a broad review of the impact of its monetary policy over the last 25 years. In this Macro Flash Note, Economist Sam Jochim assesses the implications for future monetary policy decisions.
In a statement before his first meeting as BoJ Governor, Kazuo Ueda pointed to a possible normalisation of the BoJ’s yield curve control (YCC) policy if the central bank’s inflation forecasts were close to its 2% target and had a high probability of materialising.1
The BoJ policy board members’ median forecasts for core inflation, which excludes fresh food prices, are 1.8%, 2.0% and 1.6% in fiscal years 2023, 2024 and 2025 respectively (see Chart 1). While the BoJ sees risks to the inflation outlook as being skewed to the upside in 2023, it predicts that there is a greater risk price increases will fall below its forecasts in 2024 and 2025. Market expectations align with this view, averaging above the BoJ point forecast for fiscal year 2023 and falling below it thereafter.
Source: BoJ, Refinitiv, FactSet and EFGAM calculations. Data as at 02 May 2023.
The BoJ attributes the recent slowdown in year-on-year core inflation to the Japanese government’s measures to push down energy prices. Without such measures, underlying price pressures are still seen to be accelerating in Japan.2 This has largely been a result of a pass-through to consumer prices of cost increases led by a rise in import prices and exacerbated by a depreciation of the yen (see Chart 2).
Source: Refinitiv and EFGAM calculations. Data as at 02 May 2023.
That the medium-term outlook for prices is below the BoJ’s 2% target and risks are skewed to the downside reflects the combination of an expected fading of the impact of previous import price increases, as well as an increase in the negative contribution of energy prices.
Given the limited direct impact of monetary policy on supply side factors, the lack of policy change at the BoJ meeting in April was unsurprising. Governor Ueda had implied this would be the likely outcome, noting that “you don’t want to tighten monetary policy knowing that cost-push inflation will cool the economy”.3 One of the main takeaways from the meeting was that it will require strong, demand-driven inflation for the BoJ to begin normalising its monetary policy stance.
Though it is likely to be a lengthy process, the conditions for policy normalisation under Governor Ueda are being established. In its monetary policy statement, the BoJ dropped its usual guidance on future interest rates remaining at current levels or being lowered if deemed appropriate. Most importantly, it also announced it would begin a 12-18 month broad-perspective review of its monetary policy over the last 25 years.4
The review will particularly focus on the past interactions between monetary policy and economic activity and prices. In its outlook for economic activity and prices, the BoJ alluded to the potential for upward inflation surprises stemming from stronger than expected wage growth.
It is already expected that wage growth in March will be stronger than in previous years in Japan. While data is only available until February, it shows that recent year-on-year nominal wage growth has been positive and real wage growth has been negative (see Chart 3). If wage growth in March and April is stronger than expected and real wage growth turns positive, household consumption could strengthen and lead to demand-driven inflation.
Source: Refinitiv and EFGAM calculations. Data as at 03 May 2023.
To conclude, while there were no changes to monetary policy at the BoJ meeting in April, the conditions for a normalisation are being established with a review of the last 25 years of monetary policy. Upside surprises to wage growth data in the coming months could lay the foundations for demand-driven inflation and the BoJ to raise interest rates and exit its YCC policy. However, there is a great deal of uncertainty surrounding this scenario and Governor Ueda has pointed to the BoJ remaining patient with monetary easing. In any case, the possibility of future policy normalisation is likely to be well signalled.
1 The BoJ targets a yield of 0% on Japanese government bonds with a 10-year maturity and allows the yield to fluctuate 0.5 percentage points either side of this.
2 https://www.boj.or.jp/en/mopo/outlook/gor2304b.pdf
3 https://www.reuters.com/markets/asia/bojs-ueda-how-deal-with-cost-push-inflation-dependent-economic-conditions-2023-04-26/
4 https://www.boj.or.jp/en/mopo/mpmdeci/mpr_2023/k230428a.pdf
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