Acquired Inflation Strikes Again!
Acquired inflation strikes again.
Last month, after the November CPI report, we wrote (see our note here): “the BoJ did not hike in December but in January the staff will submit updated projections and, in our view, will force Ueda to hike. […] Ueda sounded dovish yesterday but he is likely underestimating pi*. Not only, but acquired inflation for FY2024 for core-core is above 2% and above the BoJ staff forecast, which is therefore mechanically too low and (in our estimate) will be revised up in January.”
And that’s exactly what happened.
Following today’s December CPI release, the message remains unchanged since the start of the year: the distributions and our models indicate that Japan is experiencing a persistent inflationary trend, hovering around or slightly above the BoJ’s 2% target. In other words, today’s BoJ rate hike is unlikely to be the last.
A PDF containing all relevant CPI charts can be downloaded here.
A PDF containing all relevant labor market charts can be downloaded here.
MoM (saar) in line with the distributions.
We estimate that in December, the BoJ’s core index (excluding fresh food) rose 5.6% MoM SAAR (Figure 1). As for the other two core inflation measures, the index excluding fresh food and energy (core-core) increased 2.2% MoM SAAR, while the index excluding both food and energy (U.S.-style core) rose 1.6% MoM SAAR.
Today’s data aligns with the signals from the distributions.
However, given potential seasonal adjustment distortions, we continue to emphasize looking at NSA levels (see charts package), which suggest that price pressures remain persistent.
Figure 1. Estimated MoM (saar) of core inflation measures.
Note: the figure shows the MoM seasonally adjusted at annual rate of three measures of “core” inflation for the Japanese CPI.
Evidence from the distribution
Distribution centered around target. This month’s distribution remains similar to last month’s (ridge plot here). Looking at a broader horizon (Figure 2), there has been little movement in recent months, indicating that MoM readings are likely to stay in line with recent trends in the near term.
Figure 2. Distribution of CPI items ex food and energy (MoM saar, %).
Our proxies of the BoJ measures of underlying inflation
BoJ Underlying Inflation Measures (YoY) Holding Steady.
Figure 3 illustrates the three “underlying inflation” measures published by the BoJ (blue lines). For each, we’ve calculated a proxy (yellow lines) based on the distribution of price changes.
The key takeaway: Our proxies remain above the BoJ’s measures and, on average, are moving roughly sideways.
Figure 3. BoJ measures of underlying inflation and our proxies (%).
BoJ trimmed mean and our proxy
BoJ weighted median and our proxy
BoJ mode and our proxy
Note: the figure shows the measures of “underlying inflation” of the BoJ and our proxies. All figures are YoY changes, in percentage points.
Medium-term forecast
Medium-Term Forecasts Suggest (Some) Upside Risks around the BoJ Projections. Figure 4 presents our model-based forecast for the three core inflation measures, using the model by BoJ Hogen, Kawamoto and Nakahama (BoJ review, 20215).
The updated forecast remains largely unchanged from the previous one (see Table 1), as recent data have had little impact on the quarterly nowcast.
Notably, the BoJ’s revised forecast for core inflation (ex fresh food) and the FY2024 projection for core-core are now nearly identical to our model. The only divergence: Our model remains above the BoJ’s forecast for core-core in FY2025 and FY2026.
Figure 4. Medium-term model-based forecasts.
Index ex fresh food (BoJ)
Index ex fresh food and energy (core-core)
Index ex food and energy (western-style core)
Table 1. Summary of model-based forecasts
Note: The figure shows the model-based forecast of headline CPI and three measures of core CPI. The model is based on Hogen, Kawamoto and Nakahama (BoJ review, 2015). All figures are YoY percent changes. The yellow shadows are intervals of confidence calculated as quasi-out-of sample exercises. The summary table shows the average of the YoY model-based in each fiscal year (Q2, Q3, Q4, and Q1 of the following calendar year).
Trend inflation models and pi*
Pi* around 2%.
Figure 5 presents our trend inflation models for Japan, based on Rudd (2020). These models suggest that trend inflation is around 1.5%+.
Taking into account inflation expectations (with the Tankan survey broadly aligning with 2%) and general equilibrium dynamics (particularly wages), we estimate pi* for Japan to be around the BoJ’s 2% target*.
Figure 5. Trend inflation models and pi*
Note: the models mimic the ones in Rudd (2020).
“Acquired inflation” and “carryover effect”
Risks around BoJ forecast to the upside, but only at the end of the medium-term.
Figure 6 compares our model-based forecast with the BoJ’s latest projections. The table also includes estimates for “acquired inflation” and “carry-over” effects.
The key takeaway: The BoJ’s staff forecast for FY2024 is finally aligned with the models. For core inflation (ex fresh food), the BoJ’s projections now also match the models for FY2025 and FY2026.
The only upside risks remain in FY2025 and FY2026 for core-core inflation. That said, as expected, the BoJ’s core-core forecast is now at or above the 2% target across the entire forecast horizon.
Figure 6. Underlying Inflation forecast vs BoJ forecast vs “acquired inflation”
