November 4, 2015, 19:00 JST

Inflation expectation fell to 31 months low

In October 2015, the household inflation expectation DI fell to the lowest level since April 2013. One could argue that the inflation expectation the BoJ has instilled in the mind of Japanese households with its QQE program that started in April 2013 is waning off. 

The household inflation expectation DI is calculated by deducting the percentage of households who expects prices to fall in one year time from the percentage of households who expects prices to rise. In October, the percentage of households who expects the prices to go up in one year time declined from 86.3% to 81%. On the other hand, the percentage expecting the price to go down increased to 6.2% in October from 3.2% in September. 

While it is still true that the overwhelming majority of households expects the price to go up, this result is a cause of a concern for the BoJ. The inflation expectation DI chart is one of the charts the BoJ includes in its quarterly published "Outlook" reports as an indication of the general inflation expectation in Japan. The governor Kuroda has used the DI chart in the past as an evidence to back up his view that the inflation expectation in Japan is firm. He probably will not highlight the chart as much in the coming weeks.

In our view, the decline in the inflation expectation DI is an important information, but not of critical importance. Japanese consumers probably have an adaptive process in their formation of inflation expectation and it would have been difficult to stop the inflation expectation from declining while the actual price fell, driven by the decline in energy prices. 

Households' inflation expectation is certainly a factor in the wage negotiation process in Japan, but currently it is probably not an important one. The actual tightness of the labor market and its direction indicates the growth expectation of employers to be an important factor to us. Past empirical studies on the wage determination process in Japan tends to find that the labor market condition to have a dominant influence. For an example of such empirical paper, see below. We think that the BoJ would certainly take a note on the decline in the DI, but we doubt if it will cause the BoJ to change from its current hawkish stance. 

What are the characteristics of Japan's aggregate wage dynamics?

2014, Ichiro Muto, Kohei Shintani (Bank of Japan)