Japan’s inflation rate still stuck in negative territory
- Japan's Ministry of Finance will be focusing on the real effective exchange rate
- The BoJ could react to hawkish Fed talk in June by taking the opposite stance
- Withlow productivity, Japan’s potential growth rate is only about 0.5%.
By Max McKegg
An inflation update out of Japan was the main event on the economic data calendar today and it was more dire news for the Bank of Japan.
The Bank’s inflation benchmark, the Consumer Price Index (all items less fresh food) declined 0.3% year on year through April. The only consolation was that the inflation rate did not worsen a touch as some analysts had expected.
The measurement the Bank prefers to highlight, CPI less food and energy (“core” inflation) also held steady on last month at positive 0.7% year on year. USDJPY was unmoved by the numbers.
We’ll see the BoJ’s Board makes of it when they meet on June 16, a few hours after the US Federal Reserve’s own monetary policy review.
Taro Aso, head of Japan’s Ministry of Finance (MOF) tried to convince his fellow finance ministers at the G7 meetings in Tokyo last week that the swift rally in USDJPY since February fits the definition of a “disorderly market”, thereby justifying intervention by the Bank of Japan should the Ministry authorise it.
He got little sympathy for that view from his counterparts. However, they had no argument with his assessment that it would be indeed be “disorderly” if, say, USDJPY moved five big figures in the space of a couple of days.
But in exchange rate matters, the MOF is more interested in the big picture than market shenanigans.
That means concentrating on the real effective exchange rate (or trade weighted index) as the best measure of the Japan’s overall competitiveness in global markets and, indeed, the best marker for analysing who’s winning and who’s losing in the undeclared global currency war.
The real exchange rate is a combination of movements in production costs and JPY crosses. As shown in the chart below, years of low inflation and therefore production costs (relative price level) have made Japan’s export industries more competitive.
But this has been more than offset by FX moves (nominal exchange rate), the net effect being a sharp jump in the real exchange rate. For the Japanese, whether this move has been “disorderly” is a matter of semantics. Whatever way you look at it they’re losing out.
The G7 meeting may have stymied any thoughts MOF and the Bank of Japan had about retrieving the situation via FX intervention, but they will be aware there’s more than one way to skin a cat.
The Bank’s policy-making board meets on June 16, and if the Federal Reserve has either just raised its target for the federal funds rate or strongly hinted on a July move - thus boosting the USDJPY, the BoJ could give a “double whammy” impetus to the cross by taking the opposite stance.
Reading between the lines of speeches given by Board members – the latest by deputy governor Hiroshi Nakaso on Tuesday – there’s a reluctance to lower the negative policy rate any further because of the potential hit to banking sector profitability.
declined 0.3% year on year through April. Photo: iStock
“The bank seeks to exploit to the greatest possible extent any remaining room for further declines in nominal rates,” said Nakaso in central bank-speak, adding that “in introducing the negative interest rate policy scheme we were inspired by the experience of central banks in Europe”.
In theory, that “inspiration” could extend to lowering the yield curve to zero or under right across the maturity spectrum, even outdoing Switzerland.
Word yield curves
It would be a mistake to think the Bank of Japan has reached a dead end as far as quantitative easing is concerned. Its purchases of government bonds are of a similar magnitude to the Bank of England as a percentage of the amount outstanding, and its balance sheet as a percentage of GDP is smaller than Switzerland’s – or China’s for that matter.
And to deflect criticism that it’s policies are driving interest rates down to “unrealistic” levels, the Bank of Japan points out that in theory “the natural rate of interest” should, over time, match the potential growth rate of the economy.
With dire demographics and low productivity, Japan’s potential growth rate is only about 0.5%. European Central Bank president Mario Draghi recently made a similar argument with respect to the Eurozone. So low interest rates are a consequence of economic factors, not central bank policy.
US markets will likely be quiet today as traders wind down for the extended Memorial Day holiday weekend.
The Bureau of Economic Analysis will release a second estimate of first quarter GDP, and even though it is likely to be a positive upgrade to the initial estimate, analysts – and the US Federal Reserve - are more interested in what the second quarter number will be.
The Atlanta Fed provides a forecast based on “live” data updates and it currently sits at 2.9% annualised. That’s above potential for the US economy and therefore will be in the plus column when the Fed weighs up its rate hike options on June 15.
Fed chair Janet Yellen will be having a public conversation with a Harvard economist at 1315 New York time but is not expected to offer any insight into Fed policy.
A better opportunity will come when she delivers a speech on Monday June 6, one work day after the important May jobs data is released.
Since meeting my long-standing objective of 105.85 the dollar has recovered nicely. My USDJPY weekly chart analysis appears below.
-- Edited by Adam Courtenay
Max McKegg is is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade, then click here to follow him.