Japan's Central Bank May Further Delay Rate Hike Amid Cooling Inflation

Economists firmly believe that the sustained cooling of inflation will not halt the Bank of Japan's (BOJ) pace of policy normalization.

Japan's latest inflation report has given the BOJ another reason to continue waiting, while also increasing the likelihood of interest rate hikes in the coming months.

The Ministry of Internal Affairs announced on Friday that the CPI data for December, excluding fresh food, slowed to a year-on-year increase of 2.3%, in line with market expectations. The index was pressured by further declines in electricity and gas prices, as well as a slowdown in the increase of processed food prices.

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Service industry prices rose by 2.3% for the second consecutive month, marking the fastest growth in three decades, excluding distortions caused by the increase in sales tax.

Friday's data is the latest sign that Japan's cost-push inflationary pressures are easing, in line with the BOJ's previous forecasts. Previous data showed that the PPI for December was flat compared to the same period last year, the lowest level in nearly three years. In the same month, Tokyo's CPI data fell to the lowest level in over a year.

"The continued deceleration of inflation does not mean that the BOJ cannot achieve monetary policy normalization," said Taro Saito, Chief of Economic Research at NLI Research Institute. "I do not think inflation will be as strong as the BOJ expects, but it will stabilize between 1% and 2%. The BOJ may continue to predict it around 2%, so they can change policy."

Saito believes that the BOJ may raise interest rates in April. Economists surveyed by foreign media unanimously predict that the BOJ will maintain its negative interest rate policy unchanged at the meeting ending on January 23, as authorities are still assessing the impact of the earthquake that struck the northwest coast of Japan on New Year's Day.

Insiders say that the bank will also release its latest quarterly outlook at the meeting. Due to the decline in oil prices, BOJ officials may discuss lowering the core CPI forecast for the fiscal year starting in April from 2.8% to around 2.5%.

Last Friday's report showed that electricity and gas prices in December fell by nearly 21% compared to the same period last year. Subsidies for electricity and gas reduced the overall inflation rate by 0.49%. The increase in processed food prices was slower, at 6.2%. Among some anomalies, accommodation prices soared by 59%, reflecting the end of a separate government subsidy and increased demand due to the recovery of the inbound tourism industry.

A deeper inflation indicator that excludes fresh food and energy prices fell to 3.7%, also in line with expectations. Some economists say that this price indicator can more truly reflect the level of inflation because it excludes the fluctuation of energy prices, which are also affected by government subsidies. Foreign media economists said:In summary, the CPI report does not convince the Bank of Japan that the 2% target is secure. We expect the Federal Reserve to maintain policy stability at the meeting on January 22nd to 23rd.

Bank of Japan Governor Haruhiko Kuroda has stated that inflation will rise again after a temporary cooling, and a key focus will be the annual wage negotiations that will end in March. Insiders say that Bank of Japan officials believe their price expectations around 2% or higher are already high enough, and their current focus is whether the certainty of the outlook will be sufficiently raised.

While the Bank of Japan continues to view sustainable inflation as part of a virtuous cycle of wages and prices, the persistent rise in prices has been one of the factors affecting the approval ratings of Japanese Prime Minister Fumio Kishida and his cabinet, as Japanese households face the pressure of rising living costs.

Since April 2022, Japan's inflation rate has been higher than the Bank of Japan's 2% target. Due to wage growth lagging behind price increases, as of November, Japanese household real income has fallen for 20 consecutive months.

Kishida intensified his efforts to encourage companies to increase wages faster than inflation at a meeting with executives of small and medium-sized enterprises on Monday.

It is worth noting that due to the recent rebound of the US dollar to around 148 yen, Japan may face renewed pressure on import prices in the coming months.