Continuing Pressure – BoJ Forecasts Already Late
CPI came in largely in line with our expectations. The models revised up marginally the forecast. The BoJ forecast is, once again, already too low. The October CPI report came in roughly as we expected with core core marginally softer than expected and core western-style a bit stronger. Given the signals from our models, 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 for core-core with marginally more solid readings for core western-style (see western-style nsa unchained index here). A realistic forecast (MoM saar) for the next few months is around 2½-3 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 are now run with Q4 in-sample and the forecast (marginally higher than the previous run) remains above the new BoJ forecast.
Putting everything together: neutral rates. If we put all the signals together, the impression is that Japan is not facing an extreme event like the US/UK/EA did. However, it looks like the ingredients for escaping the ZLB are there and achieving the 2% target (or even a bit above it) in the medium-term looks very much possible. In this scenario, rates should be brought at least to neutral levels. In our view, the BoJ will wait to have confirmation from wage growth but by doing so it will continue to be behind the curve, a risky approach.
A PDF containing all relevant charts can be downloaded here.
MoM (saar) bouncing back. We estimate that in October the index ex fresh food (BoJ) increased at an annual rate of 7.0% (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. 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 3.5% MoM saar. Overall, today’s prints are in line (or a bit stronger for western-syle core) with our expectations and the evidence of the distributions.
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 for core-core, and continuing pressure for western-style core. 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 3.6%, and western-style core to 2.7% (bottom panels of Figure 2). In the first case, prices at the margin are running a bit lower 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
In October, the distribution (of western-style core), remained similar to the September shape (Figure 3). The distribution remains different than pre-Covid with a much thicker right tail but the difference is smaller now than in recent months and the median has already returned to pre-Covid levels.
(Note: the distributions over 3 months (see here) show that the distribution
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 tick up (but we are now careful). 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 our proxies are going sideways but remain well above the BoJ measures. Therefore, there is probably still some room for the BoJ measures to tick up this month. Having said so, the MoM (ar) of our proxies has started to decline, although they remain above the pre-Covid level (here the BoJ mode and our MoM ar proxy). For this reason, we are now more a bit more careful (note: the usual caveat about seasonal adjustment issues apply).
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). This is the first time we run the models with Q4 in-sample. We are working under the nowcast assumption that core-core will growth 3.2% (ar) in Q4, while western-style core will growth 2.7% (ar). Both figures are a bit higher than the model expected (that is, what the model forecasted for Q4). The bottom line is that the current forecast (see Table 1) is not very different from the previous run, except being a bit higher in FY2024 for both core-core and core western-style. Overall, as in previous runs, the medium-term model-based forecast remains above (or well above) the last BoJ forecast at 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 new BoJ forecast is already 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 in line with the new BoJ forecast (3.8%). In other words, in order to meet the BoJ forecast from now on, the level of the series should stop growing, an unrealistic circumstance (already happened in the last year). Not only but conditional on our forecast, the carryover for FY2024 is already 1.4%, which means that the BoJ forecast for FY2024 (1.9%) is already too low. Translated: the BoJ staff forecast looks like the ECB/NCBs staff forecast back in March (or June). The most likely scenario is that the BoJ staff will revise up again its forecast in the coming rounds.
Figure 6. Underlying Inflation forecast vs BoJ forecast vs “acquired inflation”
Implications for the BoJ
Rates (at least) to neutral. As we wrote at the beginning, the incoming data remain solid. 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. Therefore, in our view, a correct risk management would call for normalizing rates and bring them (at least) to neutral.