Core data unexpectedly cooled Can Japan's current round of inflation restart be sustainable?

The unexpected slowdown in inflation in Japan has sparked market attention.

On April 19, Japan's Ministry of Internal Affairs reported that the consumer price index, which excludes fresh food, rose 2.6% year-on-year in March, down from 2.8% in February and below market consensus expectations of 2.7%. The deeper inflation measure, which excludes fresh food and energy prices, fell to 2.9%, falling below 3% for the first time since November 2022 and below expectations of 3%.

As the Bank of Japan prepares to hold a monetary policy meeting, there is speculation about whether the slowdown in price growth will affect Japan's next rate hike process.

A recent survey of economists noted that about 41% of respondents expect the Bank of Japan to raise interest rates in October, with a small number predicting that the rate hike may be brought forward. The market's judgment is based on the fact that Japan's inflation has remained at or above the Bank of Japan's 2% target per month for two consecutive years, despite the slowdown in inflation. In particular, the depreciation of the yen continues to be weak, and there is a risk that the soaring cost of commodities will lead to further inflation growth.

At present, the Japanese government and the central bank hope to use inflation to continue to push companies to raise wages, promote demand expansion, and form a virtuous circle to help get rid of deflation. On the one hand, the Bank of Japan still has doubts about whether it can achieve a sustained and stable inflation target, and on the other hand, the situation of rising wages in Japan not keeping up with rising prices continues.

In fact, over the past decade or so, Japan has experienced several short-lived rounds of reflation, but in the end, they have become unsustainable and have fallen back into deflation. So, can this round of inflation restart be sustainable?

Image source: Xinhua News Agency

Is it an obstacle to subsequent rate hikes?

Inflation in Japan has slowed more than expected. Against this backdrop, expectations for further interest rate hikes in Japan may face a cooling down.

The data showed that the consumer price index, which excludes fresh food, rose 2.6% year-on-year to 106.8 in March, the 31st consecutive month of year-on-year increases, but fell from 2.8% in February and was below the consensus estimate of 2.7%. Specifically, the slowdown in processed food prices has dragged down the overall price index in the past month.

Ye Bingnan, an economist at CMB International, told the 21st Century Business Herald reporter that Japan's core inflation fell in March mainly because of the slowdown in the prices of durable goods, communication and entertainment services, reflecting the weakening of some consumer demand and intensified supply competition.

"There are two main reasons for the decline in inflation in Japan in March: first, the recent sharp decline in the yen, which has led to a rise in the cost of imported goods, which has limited the purchasing power of residents and dragged down consumption; Wang Xinjie, chief investment strategist of Standard Chartered China's wealth management department, told the 21st Century Business Herald reporter.

The Bank of Japan will hold a monetary policy meeting on April 26 and is expected to assess the impact of last month's rate hike. However, will Japan's inflation fall at this juncture hinder its subsequent interest rate hikes? Xiao Yu, executive director of the National Japanese Economic Association, told the 21st Century Business Herald reporter that from a series of actions after the Bank of Japan Governor Kazuo Ueda took office, the Bank of Japan's policy goal is not only to control inflation, but also to maintain the stability of the yen exchange rate.

Ye Bingnan also believes that the small decline in inflation in March will not have a decisive impact on the future movement of the Bank of Japan, and the current wage rise, commodity import prices rebound and yen depreciation and other issues will have an impact on Japan's monetary policy. "Since the beginning of this year, Japan's wage growth has risen to about 4%, and oil prices have also rebounded, indicating that inflation may continue to exceed the target in the coming period. At the same time, the sharp depreciation of the yen has aroused great concern from the Bank of Japan, which will also increase the possibility of marginal tightening of monetary policy, and the Bank of Japan may raise interest rates again in October this year. ”

Previously, Kazuo Ueda said that there is still a long way to go before "sustained and stable achievement of the 2% inflation target". But there's no denying that inflation in Japan has been largely more stubborn than expected over the past year. As of March this year, Japan's inflation has remained at or above the Bank of Japan's 2% target every month for two consecutive years. The market expects the Bank of Japan to raise its inflation forecast for the current fiscal year to 2.6% and expects prices to rise by 2% in the fiscal year starting in April 2026, partly reflecting optimism around wages and prices.

Looking ahead to Japan's rate hike path, Taro Kimura, an economist at Bloomberg Economics, expects the Bank of Japan to raise its interest rate target from 0%~0.1% to 0.15%~0.25% in July and then to 0.4%~0.5% in October. This will provide a policy cushion in case inflation loses momentum further.

However, some analysts believe that Japan's interest rate hike while domestic demand is still weak may not achieve the desired effect. Fang Ming, director and chief researcher of the Global Financial Strategy Laboratory of Southwestern University of Finance and Economics, told the 21st Century Business Herald reporter that generally speaking, the rise in inflation driven by the rise in domestic demand needs to curb demand through the monetary policy of raising interest rates, and in the face of rising inflation driven by energy prices, interest rate hikes are often ineffective. If inflation rises due to supply, raising interest rates to curb inflation will actually hurt consumer demand.

There are still risks to moving towards "reflation".

With the successive achievement of Japan's inflation target and the announcement of the end of ultra-loose monetary policies such as negative interest rates by the central bank, there has been an increase in discussion about whether Japan has come out of deflation. After all, Japan has struggled with low inflation and low growth for years.

Although Japan has experienced several rounds of reflation in the past, it has not been sustainable. Gao Ruidong, chief economist and director of the research institute of Everbright Securities, believes that the reason why Japan has achieved reflation before is that it has benefited from the recovery of domestic and foreign economies in a short cycle, resulting in a rebound in the GDP gap and rising import prices. Ye Bingnan believes that if reflation is realized, it will bring benefits to the Japanese economy. "In the short term, reflation can lower real interest rates, spur credit expansion and higher asset prices, repair private balance sheets, boost domestic consumer demand, and improve corporate earnings. ”

Now, Japan is rekindling hopes of achieving reflation. The most significant changes are that inflation in Japan has reached or exceeded 2% for 24 consecutive months, wage solidification has been broken, and the outside world expects a higher probability of a wage increase in 2024 than in 2023, and in addition, people's expectations for future inflation have risen overall, and the Bank of Japan's survey shows that the proportion of Japanese residents who believe that deflation is favorable has decreased.

Compared with the previous rounds of inflation, Japan is indeed showing a lot of changes. However, many analysts believe that it is still difficult for Japan to get rid of deflation at this stage. For example, preliminary statistics from the spring labor negotiations, which are regarded as a virtuous circle by the Japanese government, show that this year's wage increase may be higher than last year's, but the data is currently mainly concentrated in a small number of large enterprises, and the salary increase is not for everyone to benefit from the basic wage increase, and the wage increase of small and medium-sized enterprises is significantly lower than that of large enterprises. In addition, according to Japan's new labor law, the upper limit of working hours for workers will be strictly controlled from April 1, and the reduction of overtime pay will also be a factor that will dampen income growth.

On the other hand, consumption in Japan has also been suppressed. According to the latest data from the Cabinet Office, personal consumption, which accounts for more than half of Japan's economy, fell by 0.3% quarter-on-quarter in the fourth quarter of last year, showing negative growth for three consecutive quarters. Household consumption is also declining, with consumption spending by households with more than two people falling by 2.6% last year, the first decline since 2020 compared to the previous year.

At present, Japan faces multiple challenges if it is to return to the reflation process. Xiao Yu said that the constraints to Japan's reflation are that the structural problems of the Japanese economy are still difficult to solve, such as an aging population, insufficient domestic demand, a decline in the competitive advantage of overseas investment, and Japan's backwardness in emerging industries, which are not conducive to Japan's reflation.

"First of all, the government needs to support higher wages to support the economy and higher reflation. Wang Xinjie thinks. He also pointed to external disruptions, "a modest decline in global economic growth that could affect Japan's growth as an export-oriented economy." He analyzed that because of the rise in wages, Japan's inflation may rise moderately this year or even remain above the historical average, but economic growth may decline from last year.

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