"Japanese consumer prices, stripped of energy and fresh food, rose 0.1 per cent on-year in March, the first increase since 1998 and a sign that Japan could be close to shaking off 10 years of deflation."
(Only 10 years!! Deflation in Japan goes back to the early 1990s, and the crash of the housing bubble in 1992, but still). Doubtless Claus will come in with a fuller analysis as and when time permits, but I think we need to be very very careful here. We need to know where the Japanese economy is headed next before we draw any such rapid conclusions about whether or not Japan has finally "shaken off" deflation (take a look at the chart below).
I would find the argument a lot more plausible if we were now near the start of an expansionary cycle, rather than watching the sunset of one of the longest economic expansions cycles in recent Japanese history. As I indicated in my recent post, Japanese export growth weakened in March, the IMF and World Bank are predicting a slowdown in the rate of expansion of global trade, and we really need to get some measure of how the Japanese economy is going to weather this particular storm before we jump to any "over hasty" conclusions.
On the details, of the 1.2 per cent rise in the headline CPI, 0.73 percentage points were due to energy and 0.41 points came from food. According to research from Goldman Sachs the cost of mayonnaise was up 17.5 per cent year on year, while spaghetti rose 26.6 per cent and dairy products 3.8 per cent. Economists are now generally begining to characterise Japan’s rising prices as cost-push inflation.
Hiroko Ota, economy minister, characterised the rise as the wrong kind of inflation. “The price rises are being led by upward pressure from higher raw material costs and not by strong demand, so it is not a good pattern,” she said
Japanese government bonds tumbled following the release of the news, causing the biggest jump in five-year yields in nine years and forcing a halt in futures trading for the first time since 2002. Ten-year bond futures fell as much as 1.8 percent, causing the Tokyo Stock Exchange to suspend trading for 15 minutes. The yield on the 0.8 percent bond due March 2013 rose 19.5 basis points, the most since 1999, to 1.24 percent as of 3 p.m. in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price fell 0.887 yen to 97.973 yen. The yield is at the highest level since October 2007. Ten-year bond futures for June delivery lost 1.49 to 135.59 as of the close of trade. Yields on 10-year bonds increased 12 basis points to 1.6 percent, the highest since Nov. 2.
What is causing all this movement is some quick switching of bets on the most likely direction of the next move in BoJ set interest rates. Governor Masaaki Shirakawa and his colleagues will are now deemed to be more likely to stick to their policy of gradually increasing borrowing costs in their twice-yearly outlook next week. As a result investors now see a 66 percent chance of a rate increase by December compared with 38 percent before today's report, according to JPMorgan Chase & Co. calculations. As recently as March 20, traders were pricing-in a 71 percent likelihood of a cut. Whether they will raise or whether they will cut depends on a lot more than the monthly reading on the CPI (IMHO), and I think Claus's poposed measures of investment in machinery and equipment and export performance will offer us a much better guide of the future evolution of policy.
The central bank is faced with a complex set of calculations. The rising headline rate might, in some circumstances, lead it to consider a rate rise. But the difficult international situation in financial markets coupled with the low rate of the so-called “core-core inflation”, excluding energy and food, means it is far more likely to leave rates where they are at 0.5 per cent. If the economy deteriorates, bank watchers are not excluding the possibility of a rate cut.
David Pilling
