The most recent inflation release from Japan showed both headline and core inflation (which excludes fresh food but includes energy) rose 4.0% year-on-year (YoY) in December, surpassing the BoJ’s 2% target for the ninth consecutive month. A large part of this increase reflected higher energy prices, which rose 15.2% YoY.
Perhaps the most interesting development, however, was the large discrepancy between goods (7.1% YoY) and services (0.8% YoY) inflation. Given the limited direct impact of monetary policy on supply side factors, the BoJ maintaining an accommodative policy stance appears justified.
This raises the question as to why BoJ Governor Kuroda made relatively hawkish comments following the meeting on 18 January. Kuroda noted that the BoJ expects wages to rise at “quite a fast pace”. This would be an important development for underlying inflation dynamics, acting as a boost to consumer purchasing power and having the potential to cause demand led inflation. If this is the case, the Bank of Japan could begin increasing interest rates.
Lessons from history
It is interesting to consider economic conditions in Japan in 1989, the last time the BoJ significantly tightened monetary policy. The BoJ Governor Yasushi Miento’s opening speech from the meeting in April 1990 highlights some striking similarities. The BoJ judged that rate increases were necessary due to rising import costs, a depreciation of the yen and wage rises. Notably, this period marks the last time that wage growth maintained a pace above 3%, the level Kuroda has pointed to as the required pace of wage rises to sustain inflation at the BoJ’s 2% target.
The only factor missing today from those present in 1989 is wage rises. Yet tighter monetary policy is still not a foregone conclusion. When the BoJ began raising rates in 1989, it was stumbling towards a decade-long period of economic stagnation and price deflation which became known as the “Lost Decade”. This is something the BoJ would be keen to avoid.
Given that the BoJ expects growth to be above the average of the past twenty years, while core inflation is also expected to be sustained close to its target level and driven by demand factors, we could see some degree of monetary tightening from the BoJ later this year.
Pinpointing exactly when this will occur is difficult. Matters are complicated by the retirement of BoJ Governor Kuroda, on 8th April. Japanese Prime Minister Kishida is expected to nominate Kuroda’s replacement in February. Therefore, it is unlikely that the BoJ will take any decisive actions in its last meeting under Kuroda in March, with policy changes more likely at the April meeting.