Japan’s BOJ has been ‘on the wrong foot’ on inflation, analyst says

Analysts are divided over the Bank of Japan’s move after the country’s core inflation came in above the central bank’s 2% target for the 15th consecutive month.

CLSA Japan strategist Nicholas Smith is of the opinion that the BOJ has been “on the wrong foot” on inflation.

“They watched the Fed say inflation was transitory and were forced to look stupid for doing that,” Smith said in an interview with CNBC’s “Street Signs Asia.”

“They decide to ignore that and continue to project this fiscal year, 1.8% inflation. Inflation has been above 2% for 15 months in a row.”

Japan’s core consumer price index rose 3.3% year-on-year in June, in line with the expectations of economists polled by Reuters and slightly higher than the 3.2% recorded in May.

Core inflation in Japan removes the prices of fresh food from the overall consumer price index. The overall inflation rate came in at 3.3% in June, which rose slightly from 3.2% in May.

The inflation figures are key to the BOJ’s monetary policy assessments, ahead of the meeting next Friday.

In a note, Barclays economist Tetsufumi Yamakawa said much of the market still appears to view rising prices in Japan as “transient,” attributing it to “cost pressure” rather than a “demand pull.”

However, he sees a “gradually strengthening possibility” that persistent inflation will materialize with the large wage increases resulting from the latest wage negotiations, or the so-called “shunto”.

“We expect ‘shunto’ wage increases to be smaller in FY24 than in FY23, but forecast an increase of around +3%, which would be consistent with the +2% price stability target,” Yamakawa wrote.

Given this, investors will be looking for signs that the BOJ will change its stance on its ultra-loose monetary policy – or more specifically, its “yield curve control” policy.

Under the YCC policy, the central bank targets short-term interest rates at -0.1% and the 10-year government bond yield at 0.5% above or below zero, with the aim of maintaining the inflation target of 2%.

However, BOJ Governor Kazuo Ueda signaled in a recent Reuters report that the BOJ’s ultra-loose monetary policy could be maintained for now, saying “there was still some way to sustainably and stably achieve the central bank’s 2% inflation target.”

For Smith, it is “highly likely” that the BOJ will change its stance on the YCC at the next central bank meeting next Friday.

According to Smith, so-called “core-to-core” inflation – which strips out the costs of fresh food and energy – is “roaring up” at 4.2% in June. That’s the highest since September 1981, he said, adding that “its own measure shows what they’re saying is wrong.”

The CLSA strategist said the main driver of inflation is food, combined with electricity price increases, wage increases and the weak yen. Noting that wages have also seen their biggest increase in 30 years this year, he said inflation in Japan is likely to surprise to the upside going forward, driven increasingly by a wage-price spiral.

“If the BOJ does nothing, the yen will shoot through 150” against the dollar, he said. “We know from experience that intervention doesn’t work. I’ve seen 95 trillion worth of currency interventions since 1990, and the effects of that have been hours, not days.”

Smith said the BOJ’s bond purchases have increased just to maintain the YCC policy, pointing out that bond purchases have accounted for 15.8% of Japan’s gross domestic product since early December.

Ueda has said the BOJ is hitting the limit of what it can do because it already owns a third of the bond market, he added. “Now it owns 55% of the bond market and it’s starting to look like Looney Tunes.”

However, Yamakawa does not see the BOJ changing its stance on monetary policy at the monetary policy meeting in July. Instead, he predicted that the central bank will launch a phase-out of YCC at its October meeting, when the next quarterly outlook report from is released.