Market Misreads Services Inflation And the BOJ
BOJ"s Mixed Messages Add to Market Misinterpretation
Source: https://www.e-stat.go.jp/en/stat-search/file-download?statInfId=000032103845&fileKind=1
Once again, market players and forecasters appear to be misreading the intentions of the Bank of Japan (BOJ) ahead of the Board meeting at the end of January. In early December, financial markets priced in a 45% chance of a hike in interest at the December meeting. When that didn’t happen, as of late December, they priced in 45% odds for January, 60% likelihood by March, and 90% no later than April.
I believe the market is misreading not just the inflation and wage data but also the BOJ’s reaction to that data. In my opinion, the problem is not a simple mistake, the kind even the best of experts inevitably make, especially about something so uncertain. Rather, it reflects “confirmation bias,” i.e., they examined the “tea leaves” and saw in them what they expected and/or wanted to see. This group of players believes that inflation far above the BOJ’s 2% target is becoming embedded in the economy and that the BOJ has been late to recognize it. (The latest grist for their mill is services inflation, as I’ll discuss below.) Inevitably, they contend, the BOJ will come to realize its mistake and be forced to correct it. The only question is when. The sooner the better, in their eyes. They search for wording in the speeches of Governor Kazuo Ueda and others to find the shift they’re expecting. And find it they do—whether it’s there or not.
Ueda’s Excessive Ambiguity
Unfortunately, the wording used by Ueda and his fellow BOJ leaders is easy to misinterpret. The BOJ feels it necessary to say it is making progress—lest people think it’s admitting failure—while also saying the evidence is insufficiently clearcut to change its policy. That by itself would be fine. But, the BOJ sometimes muddles the message by issuing contradictory statements.
The BOJ differs from other central banks in partially holding onto an older view that the central bank can be most effective when it surprises the market. Most major central banks now believe their actions are amplified if they give the market as clear a forecast of its future actions as it can, given the uncertainties. But, as Bloomberg reported, “He [Ueda] added that policymakers were unlikely to give an explicit warning of an impending rate hike, largely discounting the kind of telegraphing sometimes employed by the Federal Reserve and the European Central Bank.”
To see the problems created by this posture, consider Ueda’s statement in a December interview on NHK TV: “It’s possible to make some decisions even if the bank doesn’t have the full results of spring wage negotiations from small- and middle-sized businesses.” The market interpreted this as Ueda preparing the market for an early move. That helped create the outsized expectations for January.
In early December, under a headline, BOJ lays groundwork for end of Japan's negative rates, the Nikkei reported, “Deputy Gov. Ryozo Himino and other policy board members signal increasing optimism on price and wage increases. Himino said at a press conference following a meeting on Wednesday that exiting the negative rate policy would have relatively little impact on Japan's economy.”
I tend to put more weight on the BOJ’s repeated comments that it needs more evidence before changing its stance. It will take until at least June or July to see whether the spring “shunto” wage negotiations result in a broad-based wage hike of 3% (the BOJ target), or, as in 2023, will disappoint by being limited mainly to the big companies. But I can certainly see why the market can jump to conclusions.
A former BOJ Policy Board member, Sayuri Shirai, a professor of economics at Keio University, criticized Ueda’s “mixed messages” in a Nikkei essay:
“At a news conference on Dec. 19...{Ueda} surprisingly suggested normalization could begin even if wage increases fail to outpace inflation....Ueda has also made repeated references in recent months to his belief that a virtuous cycle of rising wages and prices has started. Ueda's comments are surprising because ...for the April-October period, the average year-on-year nominal wage growth rate was just 1.4% if small and midsize enterprises are included, below the 1.6% expansion seen in the same period last year...The BOJ has been sending mixed signals about the direction of monetary policy under Ueda. Despite consistently emphasizing that there is still some work to do to reach its 2% target, Ueda and other policy board members have initiated forward-looking discussions on normalization while also making positive public remarks.”
Is Services Inflation Really Rising To A High Level? Are Wages?
As evidence of the kind of inflation that will supposedly force Ueda’s hand, inflation hawks claim services inflation is taking off. This is supposed to reflect growing pressure from wage hikes--rather than temporary imported inflation due to a weak yen and high prices for energy and other commodities. Therefore, they see higher-than-2% inflation being built into the economy. I think this misreads ambiguous data.
First, let’s look at the chart at the top of the blog, where the level of prices in 2020 equals an index of 100. Service prices then fell due to COVID-19 and began recovering in early 2022. As of November 2023, services prices were only 1% above where they were back in 2020. By contrast, goods prices are 12% higher than in 2020, mostly due to import-intensive food and energy.
Now, let’s look at the year-on-year inflation in the chart below. Goods inflation appears to be coming down (this doesn’t take into account the fluctuations in energy prices). By contrast, services inflation appears to be rising. November prices were 3.4% above those the prior November. That’s the smoking gun for inflation hawks
. However, what if we look at the annual rate of inflation over the past six months? In that case, as seen in the chart below, we get a very different picture. Goods inflation is going up and down. Meanwhile, the annual rate of services inflation over the past six months has fallen from its August peak of 5.6% and is now down to 2.4% as of November
. So, which of these three measures is the best predictor of future services inflation? I’m not sure. More importantly, neither is the BOJ. It says it wants more evidence before changing its current stance. In contrast to the inflation hawks, it feels that moving too early is a worse mistake than moving too late. The inflation hawks feel that, if they see things with a great deal of certitude, they’re convinced that others have no choice but to see them the same way. In the case of the BOJ, they see that change of view coming sooner rather than later.
Whither Wages
If services inflation is supposed to reflect wages—and hence the BOJ’s decade-long desire for a “virtuous cycle” between wages, income, and prices—then inflation hawks see wages rising and expect even faster wage hikes in 2024. The supposed evidence is what some big companies say they will do. However, the latter employ just a small fraction of the workforce. But here’s what the numbers show for all workers in establishments with at least five workers. It’s hard to see any upward trend in the past year, and only two months where the wage hike even equaled the 3% nominal goal that the BOJ says is necessary to achieve 2% inflation (see chart below)
Source: https://www.mhlw.go.jp/english/database/db-l/monthly-labour.html
. So, if the much-ballyhooed “shunto” results for spring 2023 failed to be a harbinger for the rest of the workforce, why should anyone jump the gun on what will happen in 2024? Why should it be surprising if the BOJ wants to see clearer evidence before changing its course? It’s not impossible that the BOJ could move as early as April, but, in that case, they’d be violating their repeated insistence on waiting until the evidence is in.
Like medicine and many other fields, central banking is a matter of balancing risks. When the evidence is, at best, ambiguous, what is the worst risk: changing course too early or too late? In choosing too early as the worse risk, the BOJ may turn out to have misjudged the situation. But it’s not being unreasonable
