September 26,2014, 12:30 JST

The new disinflation trend should prompt the BoJ to take action

There is a mounting evidence that the Japanese economy is not inflating any more. In August, core consumer price inflation decelerated from 3.3% in July to 3.1%. The deceleration also likely continued into September. The advance CPI report for Tokyo area shows that the core CPI inflation decelerated from 2.7% in August to 2.6% in September. While it would be premature to start to worry about a return of a deflation, the apparent disinflation trend should be concerning to the BoJ.

 Source: MIAC, JMA.

There are reasons to believe that the disinflation trend is real. The labor market does not seem to be tightening any more. The unemployment rate has risen from the recent bottom of 3.5% to 3.8% in July. The Japanese consumers continue to stay away from retail stores, understandably under the weight of sales tax hike. 

 Source: MIAC, JMA.

 Source: METI, JMA.

In our view, these economic fundamentals calls for an immediate action from the BoJ. In the last 18 months, the bank has already spent considerable ammunition to bring the underlying inflation rate from negative to over 1% (excluding sales tax effects). The bank now owns 22% of the whole JGB market, up from 12% before the governor Kuroda took the helm. While the concern over the BoJ's bulging balance sheet is understandable, abandoning its inflation target is not an option for the BoJ. 

 Source: BoJ,MoF, JMA.

In our view, Kuroda talking down yen in the last few weeks is a good initiative in this regards. While there are now opponents against yen weakness even within Japan, a weaker yen is still desirable for Japan to defeat inflation. It will also help Japanese companies improve their profitability, add some buoyancy to the stock market that in turn should help Japanese consumers regain confidence.

The BoJ needs to do more than just talking down yen though. The bank needs to reassure the market that the BoJ is indeed willing to do whatever it takes to defeat deflation. In our view, the first step the bank should take is to publish its outlook for its balance sheet till end of 2015. We expect the bank to take this step in their October 6-7 meeting.