Is Japan’s Inflation As High As It Seems?

It’s just 0.8% Using BOJ’s “core-core”; just 0.2% Using US Fed Core

Above: different measures of inflation, excluding hikes in the consumption tax

Bank of Japan Governor Haruhiko Kuroda faces a real dilemma. As of May, Japan’s inflation appears to be running at a rate of 2.5%, if we measure inflation by including all items without exception (dotted line light in the chart above). That would seem higher than Kuroda’s long-sought goal of 2%.

However, central banks don’t look at the headline number when they judge whether any given month’s apparent surge of inflation reflects a new long-term trend. They create their own “core” rates of longer-term inflation trends, by stripping out particularly volatile items from the headline number. The BOJ’s “core core”—its operating target—is all items except for fresh food and energy. By this measure, the trend inflation rate is still only 0.8% (the dashed line in the chart above). If we use the US Federal Reserve’s measure of “core” inflation, which excludes all food, not just fresh, as well as energy, then Japan’s trend inflation is a dismal 0.2% (heavy black line in the chart above). Food prices were up 4% in May from the year before and energy prices have risen a whopping 17%. All the rest combined showed a price hike of just 0.2%.

Where the dilemma comes in is that the headline number is the price that consumers suffer at the supermarket, gas station, and elsewhere. According to a poll conducted by Nikkei and TV Tokyo in the past week, 64% of respondents said they “cannot tolerate” price increases, while only 29% said they could. This is hurting the popularity of Prime Minister Fumio Kishida heading into the July 10 Upper House elections. While the ruling Liberal Democratic Party is still expected to do well due to the lack of viable opposition parties, it will likely than it otherwise would have.

But this kind of inflation is not what Kuroda wants. He wants inflation that is the product of healthy domestic demand. Instead, it is being produced mainly by higher prices of import-intensive items, like food and energy. And their prices are being driven higher by the tumbling yen and Russia’s attempt to conquer Ukraine. Moreover, it is coming at a time when supply-chain problems produced by COVID and the war are making growth very soft.

As a result, Kuroda says he must continue his near-zero interest rates, even though it means a lower yen and thus more “bad” inflation. PM Kishida has backed Kuroda.

Foreign bond traders, but reportedly not Japanese ones, have been betting that the falling yen will force Kuroda to relent on interest rates. That is they are betting that he will let 10-year bond rates rise above 0.25%, so as to lower the gap between rates in Japan and elsewhere. It is this gap that is sending the yen southward (see chart below).

But Kuroda has been putting his ability to create unlimited amounts of money where his mouth is. During June so far, he reportedly had to spend money at a monthly rate of ¥20 trillion ($150 billion) in that effort. And so far that’s been enough to beat the traders who predicted he would be forced to cave. The JGB has long been known as “the widow-maker” because traders who keep expecting interest rates to rise have repeatedly been wrong. Some day, these traders may yet win their bet, but that day has not yet arrived.

What Kuroda has not won is the healthy (or even unhealthy) core 2% inflation that, nine years ago, he vowed with absolute certitude that he would need no more than two years to conjure up.