BoJ: No Hurry To Raise Rates

Bank of Japan policy board member Hidehiko Haru has underlined what most Bonobo readers should already know, that internal consumption in Japan is week and that there's no threat that rising prices will cripple economic growth. Conclusion: there's no hurry to raise rates:

``Given that there's no evidence of any inflationary risk, there's no need to rush,'' Haru, 69, said today in a speech to business executives in Shizuoka city, Japan. ``Gradual adjustments will be needed and will be made based on improvements in the economy and prices.''

Governor Toshihiko Fukui and his policy board colleagues last month held the key overnight lending rate at 0.25 percent in a 6-3 vote, with most members saying they need more evidence prices will keep rising and consumer spending will improve. Fukui described data released since the decision as mixed, as exports and industrial production both surged to records while inflation slowed and household spending fell more than expected.

``Haru is basically saying there's no sense of urgency on policy,'' Katsunori Kitakura, chief treasury dealer at Chuo Mitsui Trust & Banking Co. in Tokyo. ``I don't think the BOJ will raise rates this month.''

Meantime he still doesn't seem to have gotten the full picture that this may be an ongoing structural issue with an ageing population, and he continues to hope for a 'turnaround' at some point:

``While the improvement in the household sector has been delayed, it is highly likely conditions will improve going forward,'' Haru said. ``Rising pressure on wages will steadily increase as labor shortages intensify.''

Wages fell 0.6 percent in December, the biggest drop in 16 months, the labor ministry said last month. Salaries increased only 0.2 percent last year, or about 5,500 yen ($45).

G7: Why All the Pressure on Japan?

The Group of Seven industrialized nations is meeting in Essen, Germany, later this week, and despite the fact that there are a lot of people trying hard to suggest otherwise, it appears that the topic of global liquidity will be high on the agenda.

Now what I think it is interesting for people to think about is why this is. Why does the yen loom so large in people's thoughts (even though there is no evidence whatsoever of Japanese intervention in currency markets)? Why is the Yen at such low levels? And why does the BoJ find it so difficult to raise interest rates. If you can answer these questions you will be a long way along the road towards understanding the current global economic conjuncture, IMHO.

Just to help you out, of course, Claus Vistesen had a couple of pointers on the GEM blog (and here).

Basically Japanese economic growth looks extremely shaky right now. Yesterday Bloomberg reported that the leading index (which offers a broad based reading of future economic activity) fell for the second month running, and by a significant amount to a reading of only 25%. This does not look good. And at the same time unemployment continues to run at an extremely low level, in part for demographic reasons.

So what I can't understand is why people want to keep putting pressure on Japan (well I can understand, the carry trade and all that), but I can't understand why more people are not able to think about this situation, about why it is happening, and about what the long term implications are.

Simply pushing for the BoJ to raise interest rates is only going to push Japan back into deflation, and why anyone would want that outcome is beyond me.

No signs of Inflation in Japan

by Claus Vistesen

In this note, I will adopt a two-pronged approach. Firstly, I will do a round-up of the domestic scene in Japan and more specifically the inflation outlook as well as the subsequent outlook for a possible interest rate hike by the BOJ come February or March. Secondly, I will take a look at the international perspective on Japan, where there has been a recent flurry of news items on the Japanese economy, where especially the low Yen and the carry trades are very hot topics.

In(de)flation Moving Forward?

The Japanese economy simply does not seem to be able to catch a break these days. Back at the beginning of this month the BOJ had to dissapoint financial markets yet again as the central bank failed to find room for an interest rate hike. The reason for this is not slow growth per se but more specifically the persistent sluggishness in consumer spending figures which mirrors a domestic economy where demand seems locked in towards a steady decline despite a very low nominal interest rate of 0.25%. This also materializes itself in inflation figures which can be seen in a broad as well as a narrow perspective. In terms of the former, Japan has been fighting deflation for over 5 years now with annual inflation rates in deflationary territory (2002-2005) or very close to it. In 2006 the Economist Intelligence Unit estimated consumer inflation as running at 0.3%. Looking at the latter, where are we headed as we enter 2007 then? Sadly for Japan it now seems likely that deflation is steadily becoming a once more a reality rather than a pessimistic outlook. The first aspect of this is the growth in household spending which on a y-o-y basis in 2006 probably will come in very close to stagnation or even perhaps enter negative territory. The recent retail sales figures from December bode ill for the general bullish perspective on Q4 2006 and consequently for the prospects of a BOJ raise. On a monthly basis retail revenues fell 0.2% seasonally adjusted but more importantly sales on a y-o-y basis fell 0.3% which according to Bloomberg constitutes the biggest decline in the last eight months. Retail sales are of course here used as a proxy for household spending and I am beginning to wonder whether in fact the expected increase in consumer spending in Q4 2006 will in fact not be a dissapointment. Remeber also here that the second aspect of the decline in inflation going into 2007 is the recent dip in headline inflation as a function of dropping oil prices. As Artim pointed out recently the general outlook on oil prices still points to structural forces which will tend to push up prices but for reasons explained by Artim the headline inflation rate has been dropping throughout Q4 2006 and is set to continue into 2007. This of course only acts as another hit on Japan's already depressed inflation rate which incorporates the headline account in the overall inflation measure. Looking at what this means for inflation rates in Japan and subsequently the BOJ's ability to raise in February Takehiro Sato from Morgan Stanley estimates, for example, that the CPI index will go into negative territory as early as February-March on the back of a faster than expected decline in oil prices.

However, what about the tightening labour market and the prospects of wage-push inflation as the unemployment rate keeps on drifting down, from the current level of around 4%? To scrutinize this Edward had an illuminating post over at Bonobo Land which quotes a recent article from the FT. The FT article highlights some important points on the Japanese labour market which, based on the commentary by Hiroshi Shiraishi, economist at Lehman Brothers, directs us towards an explanation for the absence of wage push inflation in Japan. The first point relates to the global phenomenon of how corporate attention increasingly is biased towards shareholders which results in the increasingly missing link between booming corporate profits and wages. This is also reflected in the global labour arbitrage argument.

The second point relates to the compostional change in the labour force as large cohorts of highly paid baby-boomers are retiring and being replaced by much thinner young cohorts, who are obviously much lower paid. Also, the labour market reforms now mean that the seniority element in wages is now much less evident, and especially in the lower skill groups. The sum total of all this is to put an inbuilt and systematic downward pressure on wages.

Thirdly, and finally, Shiraishi points to the weak yen and how this is squeezing domestic companies' foreign buying power and especially inhibiting small companies from raising wages. However, despite these strutural economic aspects another data point caught my eye in the form of the jobs-to-job seeker ration which is at 1,08 to 1,00 and marks the tightest condition since 1992 according to the FT article. So it seems that although jobs indeed are present in the economy the supply side is having trouble following the demand side which I might add is pretty strong circumstantial evidence that at least a part of the labour market tightening process in Japan is due to the sustainened process of ageing and thus compositional change of the population structure and labour force.

In conclusion, what we have here then is hardly promising signs for Japan in terms of the domestic economy's ability to produce signs which would reinforce the BOJ's willingness to justify domestically a raise in the interest rate come February or March.

A Tough Burden to Carry?

A related topic to the one discussed above about how persistingly low figuers for consumer spending and thus inflation holds off the BOJ from raising is the issue of the low Yen and subsequent the Yen carry trade which exploits the interest rate spread between low yielding Japanese government debt and high yielding debt instruments (e.g. US treasuries). The first lesson here is that the transmission mechanism is very direct between economic data and the Yen because it all relates to whether investors expect the BOJ to raise or not. Consequently, Bloomberg (linked above) reports that the Yen recently fell to a fourth year low against the Dollar on the back of the dissapointing retail sales figures cited above. More importantly, the carry trade flows and outlook seem increasingly fortified as investors continue to bet short on the Yen at the same time as expectations point to both the Fed and ECB being likely to widen the interest rate spread thus making the carry trade even more profitable. In essence the carry trade follows a perfectly rational investor approach albeit with the subtle point that it basically hinges on low volatility and thus the expectation that the high-rated currency in the carry trade will not devalue. At a later point I will go into more detail here at GEM as to what drives the carry trade. Meanwhile, the carry trade is still the source of much debate and concern in Europe and the US, a debate which translates into a concern about an unhealthy build-up of leverage. Essentially, the concern boils down to the way in which a growing number of leading European politicians and economists are voicing their dissatisfaction with what they call the undervalued Yen relative to the Euro, and thus have started to protest about the inability of the BOJ to respond to what they perceive as being the sound fundamentals of the Japanese economy and thus raise rates to unwind the carry-trade, and even more importantly in a more general global perspective to contribute to the perceived need to mopup excess global liquidity. The criticism of Japan and concern over the carry trade and excess liquidity is for example becoming operationalized in the forthcoming G7 forum. So as we gear up for the G7 meeting next week we can be sure that especially European representatives will voice their concern over the distorting nature of Japanese monetary policy. However, what does this mean? To what extent will and indeed should investors correct to the messages from G7 and more importantly will the signals transmitted by the high lords at G7 really have an impact on the Yen?

In a recent research note, Robert Alan Feldman from Morgan Stanley points to the warranty of due attention to the signals coming from G7. It is of course always good to listen, but what should not escape our attention in this case is that this would not be the first time the G7(8) forum had tried to talk up the Yen. In fact they even tried to do this as recently as last September,and at that point all the talk ended up being cheap. In fact, I am going to pick a whee bit on Feldman here since he himself, only a few days ago, suggested that investor corrected to the fundamentals of the Japanese economy instead of the rhetorics of the BOJ and the Japanese policy makers. Surely this goes for G7 rhetorics as well, or what?

Japan Consumption Falls as Output Accelerates

Here's the latest bit of news from Japan:

Japan's factory production rose to a record, while household spending fell, underscoring the central bank's concern that growth has bypassed consumers and left the economy dependent on exports to expand.

Industrial production climbed a seasonally adjusted 0.7 percent in December, the trade ministry said in Tokyo today. Household spending declined for a 12th month, falling 1.9 percent from a year earlier, the statistics bureau said.

Without a recovery in consumer spending, Bank of Japan Governor Toshihiko Fukui may delay raising the benchmark overnight lending rate from 0.25 percent, the lowest among major economies. Wages grew 0.1 percent in the third quarter of 2006, when average corporate profits surged 15.5 percent.



This a really only serves to confirm the picture Claus has been arguing. I suppose it would be rather strong language to state that the entire consensus view was almost "out to lunch" on what was actually happening in the real world these days. Something important is happening in Japan, the sign of things to come (and lets just wait till we get round to some real data for Germany for January 2007), while at the other end of the scale people seem to totally underestimate India's growth potential, and the issue is one and the same in each case: demographics. On the one hand what we are seeing is a demographic penalty, and on the other a demographic dividend. Of course, in order to appreciate that this is the case you need to at least consider the possibility - contrary to classic textbook wisdom - that demography may be an important part of the macro growth picture.