The BoJ Run Out of Bps!
The July CPI report came in just a touch stronger than expected. The NSA level of the index excluding fresh food and energy (our favorite measure of “core”) came in at 104.9 vs 104.83 expected (NSA MoM 52bps vs 44bps expected). As usual, we do not care too much about the sectoral details, and we concentrate on the distribution which remains pretty unfriendly.
Last month we wrote (here): “We remain skeptical this is the beginning of a disinflation process because the distribution of price changes has not moved and remains unfriendly. The medium-term model-based forecasts remain above the latest BoJ projections”.
The July report confirms the impression we got last month. Not only, but “acquired inflation” for FY2023 is already above the BoJ forecast with another 8 months to increase. Translated: unless the level of the series stops growing now (unlikely, given the distributions) or the data will force, once again, an upward revision of the BoJ forecast. We suspect it can happen as soon as October.
By request and for the nerds, we have put together a document that explains the concepts of “acquired inflation” and “carry-over effect”, including their algebra. The document can be downloaded here.
MoM (saar) is back. We estimate that in July the index ex fresh food (BoJ) increased at an annual rate of 3.5% (Figure 1). As for the other two measures of core inflation, we estimate that the index ex fresh food and energy (our favorite exclusion index) increased 5.9% MoM saar. This index has been running (on a MoM saar basis) above 2% since February of last year. Finally, the index ex food and energy (US-style core) increased 3.0% MoM saar. There is no surprise in today’s prints because we got a reading in line with what the distribution suggested (see below).
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 level of the series is seasonally adjusted in-house using X-13 (SEATS option).
The metrics suggest upper pressure. The metrics for headline CPI as well as for 3 measures of core inflation are shown in Figure 2. The July report has brought the 3m/3m saar of the index ex fresh food and energy to 4.4%, and the one of the index ex food and energy to 2.7% (bottom panels of Figure 2). In both cases, prices are running marginally above the YoY, suggesting that the latter has some room to tick up in the coming months.
Figure 2. Metrics of Japanese CPI indexes.
Headline CPI
Index ex fresh food (BoJ)
Index ex fresh food and energy
Index ex food and energy (US-style core)
Evidence from the distribution
Distribution still unfriendly. In July, all percentiles of the unweighted cross-section distribution of MoM (saar) changes across CPI items ex food and energy moved up (Figure 3). The distribution remains very different than pre-Covid with a much thicker right tail. Last month we wrote: “we continue to expect MoM readings around 3%+ (ar) for this measure in the next few months”. Indeed, this is what happened in July and we continue to expect the same in the near-term.
(Note: the distributions over 3 months (not reported for brevity) are showing some signs of improvements. We are very careful at the moment because this result might be influenced by the seasonal adjustment method. We will report once done investigating.)
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 using X-13 (SEATS) option.
Our proxies of the BoJ measures of underlying inflation
BoJ underlying inflation measures can go sideways before ticking up again. 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 (on-going research on this point). The takeaway from Figure 4 is that our proxies are going sideways but remain well above the BoJ measures. Not only but the MoM (ar) series of our proxies (here the BoJ trimmed mean and our MoM ar proxy) are rebounding, signaling that upside pressures are still building up.
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. 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). We do not enter into the details because we have recently circulated a note (here) with model-based simulations. The bottom line is that the models forecast (“current” in the table) is little changed compared to our note (“previous” column in the table) because the incoming were as expected. The medium-term model-based forecast remains well above the last BoJ forecast at every horizon.
Figure 5. Medium-term model-based forecasts.
Index ex fresh food (BoJ)
Index ex fresh food and energy
Index ex food and energy (US-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 is mechanically too low. Figure 6 shows a comparison between our (model-based) forecast for the index excluding fresh food and energy 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 above the BoJ forecast. In other words, in order to meet the BoJ forecast from now on, the level of the series should stop growing (in fact it should marginally decrease). While this is Japan and everything can happen, given the distribution of price changes, we think it is unlikely (the reader can see a comparison of our MoM forecast and the one consistent with the BoJ forecast in Figure 7). Translated: in our estimates, it is likely that the data will force the BoJ to revise its forecast up again in the next rounds.
Figure 6. Underlying Inflation forecast vs BoJ forecast vs “acquired inflation”
Figure 7. Underlying inflation (MoM, sa) of index excluding fresh food and energy and implicit BoJ forecast.
Note: the figure shows our MoM (sa) forecast of the index excluding fresh food and energy (the blue line). The red line is the average MoM consistent with the latest BoJ forecast.
Implications for the BoJ
BoJ waking up? Last month we wrote “The BoJ can hold for a while.. but it should realize pretty soon that its forecast is, once again, too low”. Nothing has changed. In fact, if anything, the situation got marginally worse. When will the BoJ realize it?