Unconvincingly soft
The June CPI report was a bit weaker than expected. 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, although they still converge to target at the end of the forecast horizon. BoJ on hold for now, but we need to monitor closely the models because in a quarter (or two) the medium-term forecast can be above target and trigger a YCC revision.
MoM (saar) taking a break. We estimate that in June the index ex fresh food (BoJ) increased at an annual rate of 4.7% (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 2.3% 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 1.7% MoM saar. While the MoM of core-core inflation was a bit softer than expected, we remain skeptical that today’s print can be the beginning of a disinflation process because the level of the series is not sending friendly signals (levels can be seen here) and because the distribution of price changes remains an issue (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 YoY of core-core measures can tick up in the coming months. The metrics for headline CPI as well as for 3 measures of core inflation are shown in Figure 2. The June report has brought the 3m/3m saar of the index ex fresh food and energy to 4.8%, and the one of the index ex food and energy to 2.9% (bottom panels of Figure 2). In both cases, prices at the margin are still running well above the YoY, suggesting that the latter has room to tick up again in the coming months.
(A technical note: we use the figures below as a guide for future YoY figures. The reader should remember that the 3m/3m (and 6m/6m) lines are subject to revisions because we seasonally adjust the series in-house. In the last 2 reports, the 3m/3m of tthe two core-core measures revised down a bit.)
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 does not move. In June, the unweighted cross-section distribution of MoM (saar) changes across CPI items increased the dispersion with some percentiles moving up and other down. A ridgeplot chart of the last 2 months showing the percentiles (colors) and the median (dashed line) can be seen here. In any case, in the last 3 months the distribution of price changes (Figure 3) is showing virtually no signs of movements, indicating that the core-core inflationary process is probably more persistent than what most seem to assume. For this reason, we continue to expect MoM readings around 3%+ (ar) for this measure in the next few months.
Figure 3. Cross-section distribution of MoM (%, ar) of CPI items ex food and energy
Note: the Figure shows the median (black thick line) and the percentiles of the cross-sectional distribution of MoM saar items. The distribution excludes food and energy items. The levels of the series (about 300 in total) are seasonally-adjusted in-house using X-13 (SEATS) option. The percentiles shown are the 5th, 10th, 25th, 75th, 90th, and 95th.
Our proxies of the BoJ measures of underlying inflation
We expect the BoJ underlying inflation measures to tick 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 there is room for the three measures to tick up in the next release, especially for the BoJ trimmed mean and the BoJ weighted median.
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). The evidence in Figure 5 is the result of revised assumptions for the output gap (a bit lower), oil prices, and import prices (a bit lower), as well as today’s incoming data. Overall, the revised assumptions / incoming data resulted in a slightly lower forecast throughout the medium-term. Neverhtless, the models continue to signal upside risks around the latest BoJ projections. Table 1 shows a summary of the model-based medium-term forecasts. In this moment, the model forecasts are above the latest BoJ forecasts 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).
Implications for the BoJ
BoJ to hold… for now. 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”. The data in the last two/three months are a confirmation that inflationary pressures remain high and above what is implied by the BoJ forecast. If the BoJ staff is using the model by Hogen, Kawamoto and Nakahama (2015) to forecast inflation, it might rely on the fact that the forecasts converge around 2% at the end of the medium-term. Having said that, the experience of the US/EA/UK/Canada/Norway/etc.. should be taken as a warning. The BoJ can hold for now but if the data continue like in the last few months, the future is like flipping a coin.