Given the BOJ’s inflation target, it may seem odd that the central bank has taken such a dovish policy stance while inflation has persistently been above target. Indeed the BOJ seems much more cautious about undershooting its target than overshooting it after decades of below-target inflation. It wants to ensure that inflationary pressures persist so that it can finally abandon its negative interest rate policy, which will likely require several changes in economic data.
The first change the central bank likely needs to see before raising rates is stronger services inflation. Most of the above-target inflation seen last year has been due to goods. For example, goods inflation reached 7.3% in January while services inflation was running at 1.1%. The central bank correctly assessed that much of the goods inflation would prove to be transitory, as goods inflation eased to 4.2% in August. However, services inflation has picked up just as goods inflation came down. In August, services inflation was 2%—the highest reading since 1998.6
Even if services inflation continues hovering above 2% in the coming months, it is unlikely to be sufficient to warrant a change in monetary policy on its own. Stronger wage growth will likely need to accompany higher services inflation. Indeed, during the press conference following the last central bank meeting, Governor Ueda noted the importance of wage growth in determining the persistence of inflation and therefore future monetary policy changes.7
As we mentioned in our previous Japan economic outlook, wage growth perked up after the annual shunto. However, scheduled wages, which exclude overtime and bonus payments, were up just 2.1% from a year earlier in July for establishments with at least 30 employees (figure 2). Wage growth for smaller establishments was even lower. Although this is a notable improvement from previous years, wage growth is still running below inflation and will likely need to move higher for central bankers to feel confident about sustainably achieving their mandate. This contrasts with what other developed central bankers are experiencing. In the United States and Europe, inflation adjusted wages are rising, which has put additional pressure on their central banks to take a more hawkish stance.
As an economic analyst with a deep understanding of central banking policies and macroeconomic trends, I bring a wealth of knowledge and expertise to the discussion of the Bank of Japan's (BOJ) inflation targeting and policy stance.
Firstly, it's crucial to recognize the context of the BOJ's inflation target and its dovish policy stance. Despite persistent inflation above the target, the central bank has adopted a cautious approach, prioritizing the avoidance of undershooting rather than overshooting the inflation target. This strategic choice has historical roots in decades of below-target inflation, shaping the BOJ's commitment to ensuring sustained inflationary pressures.
One of the key insights into the BOJ's current stance lies in its concern about the composition of inflation. While overall inflation has been above target, the central bank has rightly identified that much of the recent inflationary pressure is driven by goods rather than services. For instance, goods inflation reached 7.3% in January, whereas services inflation lagged significantly at 1.1%. The central bank correctly anticipated the transitory nature of goods inflation, as it eased to 4.2% in August. However, a noteworthy development is the rise in services inflation to 2% in August, marking the highest reading since 1998.
Despite this increase in services inflation, the BOJ remains cautious about making immediate policy changes based solely on this factor. The analysis suggests that the central bank is likely looking for a more comprehensive set of indicators to support a shift in its monetary policy. One crucial element is stronger wage growth, as emphasized by Governor Ueda during the press conference following the last central bank meeting.
The importance of wage growth is underscored by the observation that even though wage growth perked up after the annual shunto, scheduled wages (excluding overtime and bonus payments) were up only 2.1% from a year earlier in July for establishments with at least 30 employees. This figure, while an improvement from previous years, still falls below the inflation rate. In contrast to the situation in Japan, developed countries like the United States and Europe are experiencing rising inflation-adjusted wages, putting pressure on their central banks to adopt a more hawkish stance.
In summary, the BOJ's cautious approach to its inflation target reflects a nuanced understanding of the underlying factors driving inflation, particularly the need for a balanced contribution from both goods and services. The central bank's focus on stronger services inflation and, crucially, wage growth highlights a deliberate and comprehensive strategy to ensure sustained and broad-based economic recovery before considering a shift in its policy stance.
