Japan’s economic scars might blind it to inflation

Toshiba

13/06/2023 03:29

(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)
    By Pete Sweeney
       TOKYO, June 13 (Reuters Breakingviews) - Bank of Japan
Governor Kazuo Ueda knows well the risk of tightening policy
prematurely. Attempts to slow stimulus and raise borrowing costs
by his predecessors have backfired repeatedly since 1997.
Investors worry about market ructions if Ueda hikes rates now
but there is another risk: that he waits too long. 
    Since taking the helm from Haruhiko Kuroda in April, Ueda
has enjoyed a quiet market honeymoon. The yield on the benchmark
10-year bond has stopped testing 0.5%, the high end of its
trading band set by the BOJ, and the Nikkei 225 large-cap equity
index, up 20% in the last three months per Refinitiv data, is
the world’s best performing major benchmark, slightly ahead of
the Nasdaq Composite.
    That is because Ueda’s decision to keep ultra-low interest
rates in place for now has eased investors’ worries that rising
inflation and a collapsing yen would force him to start
tightening monetary policy right out of the gate. That could
have prompted an accelerated repatriation of funds Japanese
investors have parked abroad in search of better returns – a
process that is already getting underway as currency hedging
costs rise. Bank for International Settlements data shows
Japanese entities held over $5 trillion in overseas assets at
the end of 2022, higher than any other country. 
    Ueda’s inaction – and the domestic markets’ positive
response – have bought him time to focus on evaluating
macroeconomic fundamentals, particularly inflation. Here is
where his job gets complicated. 
    The country only emerged from a decades-long deflationary
rut relatively recently, so local economists, executives and
consumers are unused to worrying about consumer prices rising
too fast. That might help explain why many policymakers and
economists dismiss the recent spike as temporary, driven by
imported factors. Yet that may be changing. The economy has
exited recession, and the “core-core” Consumer Price Index,
which excludes volatile food and energy items, rose at an
annualised rate of 4.1% in April, well above the BOJ’s 2%
target. In addition, the general services component, which
excludes government services and is largely insulated from
external factors, is now growing at an annual rate of 2% a year,
a 28-year high. The unemployment rate is falling and private
consumption is rising, as is demand for credit.  
    If workers demand and get higher wages to compensate for the
jump in their living costs, Japan could face a long-term rise in
inflation that would need a gradual monetary tightening.
Unfortunately for Ueda, the picture is muddy. Annual wage hikes
negotiated by the country’s largest unions in April averaged
around 3%: high by historical standards but below CPI - albeit
with some dramatic exceptions like Fast Retailing  9983.T ,
owner of the Uniqlo clothing chain. And an intense worker
shortage in some sectors is pushing up non-union and informal
pay.
    TIMING THE MARKET
    It is worth remembering that Japan was once one of the
world’s frothiest economies. Ripping export-driven growth led by
manufacturing champions like Toyota Motor  7203.T  and Toshiba
 6502.T  helped fuel exuberant speculation in domestic real
estate and shares between 1986 and 1991.  
    The BOJ recognised the problem as early as 1987 but
officials were rattled by the Black Monday stock market crash in
the United States. They waited two years to act. When the
central bank officials began belatedly raising rates, they set
off a collapse in land prices comparable to the U.S. Great
Depression in the 1930s. Economist Richard Koo estimated falling
values erased 1,500 trillion yen ($9 trillion in 1990 dollars)
of national wealth, the equivalent of three years of GDP. 
    Japan is nowhere near to the frothy conditions of the 1980s,
when the economy expanded at rates ranging between 3% and 7% per
quarter. Output grew only 1.6% on an annualised basis in the
three months ending March and external demand for Japanese
exports is weak. Japan Inc still sits on vast uninvested
reserves.
    The threat of a demand-driven inflationary spiral still
seems far-fetched in a slow-growing, fast-aging nation where
cash-hoarding has been reflexive. Since Japan’s bubble popped,
attempts to pull back on fiscal spending, hike consumption taxes
or lift borrowing costs have proven ill-advised. Hiking
benchmark interest rates in 2000 was disastrous – long term
lending rates actually fell in response, and the decision had to
be reversed. Ditto for a more recent experiment by then-Prime
Minister Shinzo Abe with raising the consumption tax. The
government’s latest draft of its long-term economic plan, seen
by Reuters on June 2, remains focused on eradicating Japan's
“long-held deflationary mindset”. 
    But the global economic context has now changed completely,
and long-running trends like supply chain diversification out of
China look to keep sustained upward pressure on costs. In that
context, a combination of rising prices and tepid growth would
be especially hard on a society like Japan, where so many
pensioners live on fixed incomes. 
    The risks are clear. In 2021 and 2022, central bankers in
the United States and Europe disregarded signs prices were
getting out of hand until very late in the game, with less
excuse than the Japanese. The resulting steep rise in interest
rates - since March 2022 the Fed has yanked its target to a
range of 5% to 5.25% from 0.25% to 0.5% - whipsawed securities
markets and caused bank failures in the United States. Germany
and Italy, both of which have similarities to Japan, are still
struggling to revive their economies. 
    There is little evidence that prices are overheating yet.
But if they do, recent history shows time is off the essence. If
policymakers dither, they might end up having to dramatically
tighten policy in a belated panic as Western central banks did.
That would knock down bond prices and set off a sharp yen rally
- the currency has lost over a quarter of its value against the
dollar since 2021. A jump in the yen would damage Japan’s
exports and depress the local-currency value of overseas sales
at major exporters like Toyota, hurting profitability. Economic
growth, which the International Monetary Fund expects to be a
meagre 1.3% in 2023, would probably contract and trillions of
Japanese dollars would come back home from overseas equities,
fixed income, mutual funds and private equity. That could
deliver an even harsher global shock than premature
normalisation.  
    Follow @petesweeneypro on Twitter

    CONTEXT NEWS
    Japan's wholesale inflation slowed for a fifth consecutive
month in May because of sliding fuel and commodity prices,
official data showed on June 12. The corporate goods price
index, which measures the price companies charge each other for
goods and services, rose 5.1% in May compared with a year
earlier, slower than the median market forecast for a 5.5% gain.
    Bank of Japan Governor Kazuo Ueda said on May 30 that the
central bank would patiently maintain its ultra-loose monetary
policy because he believed current high inflation levels would
not be sustained. "We expect inflation to quite clearly slow
below 2%" toward the middle of the current fiscal year, Ueda
told parliament.  
    Consumer prices excluding volatile food and energy items
rose 4.1% in April, outpacing the core measure by 70 basis
points. 
    The Bank of Japan’s next policy meeting will end on June
16. 



    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Graphic: The cost of delay    https://tmsnrt.rs/3p3o7TW
Graphic: Pulling out    https://tmsnrt.rs/43At7P7
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Editing by Francesco Guerrera and Katrina Hamlin)
 ((For previous columns by the author, Reuters customers can
click on  SWEENEY/ 
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS https://bit.ly/BVsubscribe
 | pete.sweeney@thomsonreuters.com; Reuters Messaging:
pete.sweeney.thomsonreuters.com@reuters.net))