- August’s core inflation continues to fall, while economic activity remains weak
- Further monetary easing will depend on third quarter GDP growth and approval of VAT hike in December
Japan’s difficult task of achieving price stability…
August’s core inflation – excluding fresh food – was 3.1% down from 3.3% the previous month. If the effects of the sales tax are excluded, inflation is around 1.1% in August. This is closer to the lower end of the central bank’s range of 1%-1.5%. Authorities in Japan aim to beat deflation, by supporting a weaker yen as a trigger to reduce the output gap. Wage rises would follow and inflation expectations would sharpen. This process had a good start as core inflation was at -0.4% in April 2013 when Quantitative and Qualitative Easing (QQE) was introduced and has risen to above 1% since November 2013. But lately progress in the strategy has been disappointing. Inflation expectations have been adjusting downwards, despite the yen’s depreciation. The yen trade weighted index has depreciated by 12% since April 2013.
…as economic activity weakens
Data released in the past months suggest that the economy is struggling after this year’s 3 percentage point VAT hike. Indeed, Japan’s first preliminary release of the second-quarter GDP growth showed a contraction of 1.7% qoq (6.8% qoq annualised), compared to 1.5% qoq (6.1% qoq annualised) in the first quarter. Both consumer and housing spending fell significantly in the second quarter after the pre-tax hike demand surge.
A more recent report released a few days ago, showed that Japan’s flash manufacturing PMI fell 0.5 ppts to 51.7 in September, although the level is still higher than the second quarter average. The details are, however, not constructive. New orders slid in both total and export. Furthermore, the recovery in household expenditure has not materialised as wage growth continues to lag inflation. As such there are concerns that economic growth will not be strong enough to push core inflation, excluding the effects of sales tax, towards 2% within the next one year.
Outlook: more monetary easing ahead
The Governor of the Bank of Japan (BoJ) mentioned a few days ago that if needed the BoJ would adjust monetary policy. Moreover, as the US economy continues showing a strong performance, further weakening of the yen is likely to boost Japan’s export growth, while adding some upward pressure on inflation. Indeed, the BoJ expects an upwards trend in the CPI to follow in the second half of the year. We think that the slow pace of price increase will likely require some fine tuning in monetary stimulus that will likely push up inflation in 2015. This could occur as soon as 31 October when the BoJ gives an update on their outlook for the economy and inflation, which we expect will be more pessimistic than the previous. If needed incremental steps or additional QQE will follow after the release of Q3 GDP in the middle of November or after the approval of the new VAT hike in December and that will only take effect in October next year.