Èureka!
Preamble: Since June/July 2023, we have been arguing that the conditions to exit the YCC and normalizing rates were in place. Back then, we were completely out-of-consensus. The BoJ has finally hiked. Èureka! The next steps should be normalizing rates and raise them to neutral.
Core CPI came in as (we) expected and in line with the signals of the distributions. The medium-term model-based forecasts are little changed. The BoJ forecast continues to be too low. The February CPI report came in as (we) expected, in line with the distributions. Overall, the message of this update is basically identical to the last few months. As in previous updates, we split the message between (i) the near-term (the next 3 months or so) and (ii) the medium-term forecast. When looking at (i), the distributions suggest no acceleration. A realistic forecast (MoM saar) for the next few months continues to be around 2-2½ percent range for both core-core and core western style. On the other hand, when looking at (ii), which is more relevant for monetary policy, the medium-term models remain above the BoJ forecast and above target.
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) around target, as expected. We estimate that in February the index ex fresh food (BoJ) was flat (Figure 1). As for the other two measures of core inflation, we estimate that the index ex fresh food and energy (core core) increased 2.3% MoM saar. Finally, the index ex food and energy (US-style core) increased 1.7% MoM saar. Today’s prints are in line with our expectations and the evidence of the distributions which point to short-term readings (MoM saar) around target. The NSA indexes (see here the NSA level by year of core-core, and here of core western-style) also suggest that the YoY should be around target by the end of the year.
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.
The metrics suggest some cooling. The metrics for headline CPI as well as for 3 measures of core inflation are shown in Figure 2. Today’s report has brought the 3m/3m saar of core-core to 2.2%, and western-style core to 2.2% (bottom panels of Figure 2). In the first case, prices at the margin are running lower than the YoY, suggesting that the latter has room to tick down in the coming months. In the second case, the metrics suggest a continuing pressure with the YoY expected to go sideways in the near-term going forward.
Figure 2. Metrics of Japanese CPI indexes.
Headline CPI
Index ex fresh food (BoJ)
Index ex fresh food and energy (core-core)
Index ex food and energy (western-style core)
Evidence from the distribution
Distribution centered around target (Figure 3). This month, there is no clear signal from the distribution as some percentiles moved up and some down. The distribution (of western-style core) is now centered around target, and a bit less dispersed than in recent months. This is a promising sign to reach target on a persistent basis, and suggests moderate sequential readings in the near-term (i.e. MoM saar around 2%+).
(Note: the distributions over 3 months are here and suggest that in the last three months the distribution is nearly identical to the previous months)
Figure 3. Ridge plot of cross-section distribution of MoM (%, ar) of CPI items ex food and energy
Note: the Figure shows the cross-section distribution of MoM (%, saar) of CPI items ex food and energy. The dashed black line indicates the median. The colors show the percentiles (<10pct, 10pct-25pct, 25-75pct, 75-90pct, and >90pct). The levels of the series (about 300 in total) are seasonally-adjusted in-house.
Our proxies of the BoJ measures of underlying inflation
BoJ underlying inflation measures (YoY) can move sideways. Figure 4 shows the three measures of “underlying inflation” published by the BoJ (the blue lines). For each measure, we have calculated a proxy (the yellow lines) starting from the distribution of price changes. The takeaway from Figure 4 is that some of our proxies remain above the BoJ measures and they are going roughly sideways. The MoM series (here the BoJ mode and our MoM ar proxy) are also going sideways right now.
Figure 4. 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
The medium-term forecast points to upside risks around the BoJ projections. Figure 5 shows our model-based forecast for the three measures of core inflation using the model by BoJ Hogen, Kawamoto and Nakahama (BoJ review, 20215). The bottom line is that the current forecast (see Table 1) is very close to the previous run, as the Q1 nowcast was little affected by the February data. Overall, as in previous runs, the medium-term model-based forecast remains above (or well above) the last BoJ forecast (and the 2% target) at almost every horizon.
An Excel file containing all data of Figure 5 can be downloaded here.
Figure 5. 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).
The “acquired inflation” issue of the BoJ
The BoJ forecast continues to be mechanically too low. Figure 6 shows a comparison between our (model-based) forecast for BoJ core and core-core vs the BoJ latest forecast and the estimated “acquired inflation” and “carry-over” effects. The main takeaway is that “acquired inflation” for FY2023 is already at the level of the BoJ forecast (3.8%) of the entire year. In other words, in order to meet the BoJ forecast from now on, the level of the series should stop growing. Not only, but conditional on our forecast, the carryover for FY2024 is already 1.3%-1.4%, which means that the BoJ forecast for FY2024 (1.9%) is already too low. The risks around the BoJ staff forecast are to the upside, including at the end of the medium-term forecast. The most likely scenario is that the BoJ staff will revise up again its forecast.
Figure 6. Underlying Inflation forecast vs BoJ forecast vs “acquired inflation”
Implications for the BoJ
Rates (at least) to neutral. This month, there were no surprises in the data, and we expect moderate readings in the near-term. The main message is the same of the last few months: it is hard to imagine core inflation accelerating to 6% as in the US or the EA. Nevertheless, the models suggest that the BoJ forecast is too low and that achieving 2% in the medium-term is possible. The BoJ has (finally) hiked. The next steps should be to bring rates to neutral.