Year of the Dog: Can Japan kick inflation into gear?

AsianInvestor's latest Year of the Dog prediction question looks to Japan, and asks whether the nation will finally succeed in getting inflation to take hold.
Year of the Dog: Can Japan kick inflation into gear?

The Japanese government has allied with the nation's central bank on a pronounced strategy to promote domestic inflation and get more people to stop saving their money and instead invest it.

This strategy has had mixed success to date, but with Japanese prime minister Shinzo Abe gaining a new electoral mandate in 2017 it looks as if there is a new lease of life to these efforts.

This led AsianInvestor to ask in our latest Year of the Dog outlook predictions:

Will the Bank of Japan’s quest to create inflation succeed?

Answer: No

The Bank of Japan (BoJ) first introduced its 2% inflation target in January 2013. Five years later the goal remains elusive, despite both the central bank and government conducting enormous monetary and fiscal stimulus efforts. 

Japan has endured deflation since the 1990s, following the collapse of the asset price bubble in the early part of that decade. Creating meaningful price rises once more is a central part of the bank’s aims to grow the economy. If inflation exists, people will be incentivised to invest more instead of parking money in banks. Plus, inflation can help erode the country’s still-vast debt burden. 

But it’s proving hard to generate. Last July, the BoJ pushed back the expected timeline of the inflation target for the sixth time since 2013 to sometime in 2019, after the inflation rate had stayed at 0.4% for four consecutive months. 

However, the latest consumer price index (CPI) data seems to indicate that inflation may finally be on the rise. 

After hitting a low of -0.5% in September 2016, the annual CPI growth rate has more or less trended in an upwards trajectory since, reaching 1% in December 2017—its highest level in 33 months.  With a low unemployment rate, continuing global synchronised pickup, and increasing commodity prices, it certainly looks like conditions are in place for a steady rise in Japan’s inflation rate in 2018.

However, AsianInvestor believes it’s still too soon to see the BoJ finally achieve its coveted 2% objective. Its ability to generate more inflation depends largely on the housing rent component of the CPI. The weighting of this component makes up a hefty 20% weighting of the CPI figure, according to OECD data, and rental prices have been trending downwards since May 2016. The latest data from December 2017 shows housing rent-only inflation rate at -0.1%.

Additionally, while Japan’s unemployment rate is low, measured at 2.8% in December 2017 versus 3.1% in December 2016, this belies the fact that around 22% of employed persons in Japan are part-time workers, according to October 2017 figures on part-time employment data from government agency Statistics Japan. The lower salaries of part-time workers, as a result, will also hamper any efforts to meet the inflation target.

Japanese Prime Minister Shinzo Abe still has the potential to achieve the 2% goal. His robust election win in October secured him a strong mandate to continue the country’s current monetary policies. However, the current rate of inflation growth, which the OECD notes grew from 0.4% in January 2017 to the current rate of 1%, makes it unlikely for a 2% figure to be attained before the end of the year. 

Low inflation isn’t necessarily a bad thing, especially for investors. The MSCI Japan index was up around 24% in 2017 after all, and it has risen around 12% over the last three years.

Furthermore, the low inflation will likely convince the central bank to continue its accommodative monetary policies, which has tended to be a positive for stock markets.

Previous Year of the Dog predictions:

​Are European and UK securities a good bet this year?

Will the US Treasury yield curve invert?

Will Donald Trump still be president at the end of 2018?

What will be the best performing asset class, on a risk-adjusted basis?

¬ Haymarket Media Limited. All rights reserved.