Japan inflation expectations weaken in Oct, may prompt further BoJ easing

On Friday Nov 27, Japan's consumer price index (CPI), household expenditures and an update on the employment situation are due for release. Data will be closely watched after indicators last week showed Japanese exports fell for the first time in 14 months in October and the economy slipped into recession in the July-September quarter. The Bank of Japan's main inflation gauge dropped for a second consecutive month in Sept as the effects of low oil prices continued to take a toll. Expectations are for Japan's nationwide CPI (excluding fresh food) to fall to -0.2% y/y in Oct, and if so, it will mark the third consecutive monthly decline (was -0.1% y/y in Sept). 

The BoJ highlights that factors such as the passing on of price increases to products as a result of cost-push inflation caused by yen depreciation and the recovery in domestic demand are helping to push up inflation, especially for CPI (ex fresh food and ex energy) which is rising firmly. However, this is not sustainable inflation if there is no expansion of demand. Japanese households and financial institutions have gradually been taking on more "healthy" risks, but consistent wage increases need to be seen before they will tolerate rising prices, which would in turn help boost inflation toward the 2 percent target. 

"Japan CPI is only expected to reach around +1.0% yoy by mid-FY2016 and inflationary momentum is much weaker than the BoJ is expecting", notes Societe Generale in a research report. 

Japanese inflation will likely rise in the near future so long as oil prices don't fall further, Bank of Japan board member Sayuri Shirai said last week, but higher wage growth remains key to reaching the central bank's inflation goal. Economists at Societe Generale expect wages to increase due to tight labour supply and demand, and the base effect of declining oil prices disappearing in Q1 2016, which could push up inflation. However, this scenario is not expected to start to take shape in 2016, it will be difficult for the BoJ to achieve its price stability target of 2% by "around the second half of FY16" (this includes the possibility of the first half of FY17).

"In contrast to 2014 and 2015, we expect wage increases to come before delayed inflation, which should result in a rise in real wages and in turn stimulate consumption. We focus on whether unemployment which is currently below NAIRU (3.5%) could fall further to below 3.0%. This would lead to a further tightening of labour supply-demand and stronger upward pressure on wages, leading to an acceleration in inflation caused by the expansion of consumption", says Societe Generale.

Continued commodities' rout combined with subdued domestic demand will likely dampen price growth in Japan and for now the central bank's 2 percent inflation target by mid-2016 remains out of reach. Inflation expectations have also weakened in October, and this may prompt the Bank of Japan to ease monetary policy further. 

USD/JPY was capped below 123 handle on the day after having crawled off last week's low of 122.62. BoJ minutes will take centre stage in Japan early tomorrow. The pair is trading at 122.57 as of 1006 GMT after hitting lows of 122.40 on the day.