BoJ to remain dovish as inflation disappoints

Underlying inflation undershoots expectations

Core inflation, as measured by the Consumer Price Index (CPI) excluding fresh-food and energy, unexpectedly slowed in June from 0.3% year-on-year (YoY) to 0.2%. This compares with consensus expectations of a tick up to 0.4% following a rise in the June Tokyo inflation print, which tends to lead the national series.

CPI excluding fresh food, which is targeted by the Bank of Japan (BoJ), edged up to 0.8% YoY driven by higher energy prices. However, inflation remains well below the 2% target set by the central bank.

BoJ to stay on hold

This inflation release will be a disappointment for the BoJ ahead of its next monetary policy meeting at the end of the month. We expect the central bank to keep monetary policy unchanged. Under yield curve control, which began in September 2016, the BoJ pledges to keep short-term interest rates at -0.1% and guide the 10-year government bond yield to “around zero per cent”.

The BoJ will also publish its new Outlook report, where the prospects for inflation are likely to be downgraded given the disappointing inflation data for the second quarter as a whole. This means the BoJ should maintain its dovish stance, highlighting the continued need for powerful monetary policy with persistence.

Trade wars also on the radar  

Following the announcement of the US administration’s intention to apply tariffs on an additional $200 billion of Chinese goods, the trade spat between the US and China is threatening to escalate into a trade war. This is likely to have spill-over effects to the wider Asia region. While we do not expect this to impact monetary policy at this stage, some board members of the BoJ are likely to voice some concern on the risks to global trade.

The recently agreed EU-Japan trade deal, which has been in the works for years (and is expected to come into force in 2019), confirms Japan’s stance on free trade. Japanese Prime Minister, Shinzo Abe, said: "…we are sending out a message emphasizing the importance of a trade system based on free and fair rules."