Japan deflation may trigger more BOJ action

Analysts say that while the BOJ will want to save its ammunition for when sharp yen rises hurt a fragile economy, it may have to act around June, when government pressure for more steps could escalate ahead of upper house elections expected in July.

“The government will continue to pressure the Bank of Japan for action, given that the market is becoming increasingly cautious about each country’s fiscal deficit,” said Takeshi Minami, chief economist at Norinchukin Research Institute.

“The BOJ may act around June or July, either by expanding its fund-supply operation adopted in December or by increasing its outright government bond buying.”

The so-called core-core consumer price index, Japan’s narrowest measure of price gauge that excludes volatile food and energy costs, fell 1.2 percent from a year earlier, matching a record drop the month before.

The indicator, similar to the core index used in the US, fell for the 13th straight month, in a sign that weak demand was forcing companies to cut prices to lure consumers.

The nationwide core CPI, which excludes volatile food prices but includes energy costs, fell 1.3 percent in the year to the end of January. That was slightly smaller than a median market forecast of 1.4 percent fall but marked the 11th straight month of annual declines.

The core CPI index reading of 99.2 was the lowest in 17 years.

Keeping the pressure on
The Democratic Party-led government, faced with falling support rates, wants to avoid an economic downturn ahead of the summer upper house elections and has been urging the BOJ to support the economy even as most other major central banks examine rolling back stimulus.

Finance Minister Naoto Kan told reporters again after the CPI data was released that he expected the central bank to work towards ending deflation.

Many analysts say the BOJ’s most likely next step is to expand the fund-supply operation it adopted in December, either by raising the amount from 10 trillion yen ($112.2bn) or extending the duration of loans from three months.

The BOJ may also opt to increase its long-term government bond buying from the current 21.6 trillion yen per year, a move that would please the government if bond yields shoot up on concern over Japan’s fiscal deficit.

Assuming the BOJ doesn’t change the duration of assets it holds now, a lack of further central bank action would mean a sharp decrease in its balance sheet and therefore liquidity contraction at a time when Japan is still in deflation, said Robert Rennie, chief currency strategist at Westpac in Sydney.

“I fully expect additional quantitative easing measures through this year, and one will be an increase in ‘rinban’ operations” to buy JGBs outright.”

The BOJ is forecasting three years of deflation and has said it is committed to keeping interest rates near zero for as long as necessary. But it has offered few clues on what it might do beyond that to beat deflation.

Deflation hurts the economy as households put off spending on hopes that prices will fall further, forcing companies to cut prices to lure consumers.

The BOJ has caved in to government pressure before, when it introduced the three-month funding operation in December after a barrage of criticism that its economic assessment was too rosy.

Still, Naoki Minezaki, one of Kan’s two deputies, told reporters in an interview that while some in the government wanted the BOJ to loosen monetary policy, setting a rigid inflation target may not be the way to get the country out of deflation.

The finance minister said earlier in February that he would favour inflation of around one percent, although he did not specifically refer to an inflation target.

While that figure roughly matches the BOJ’s view, the mere mention of it by Kan was a sign the government was stepping up pressure for more BOJ action.

In a positive sign for the economy, industrial output rose much more than expected in January, as manufacturers ramped up production to meet demand from fast-growing Asia.

While market reaction to the CPI and output data were muted, the stronger-than-expected output figure capped gains in Japanese government bond futures.