Inflation in Japan falls, proving the BoJ’s dovish strategy right

Inflation in Japan declined in September to 3% annually, fresh data on Thursday showed. This is much lower than expected by markets, who were pricing in a slight increase from the last reading.

Inflation in Japan has lived a life of its own for almost the entire 2023, with the Bank of Japan refraining from any meaningful action to stop. September is the third consecutive month with Japanese inflation above the 2% target.

Nevertheless, inflation has cooled from the 3.2% year-on-year reading from August. A sign that consumer prices could still be under the Bank of Japan’s control.

According to Shotaro Kugo, a senior economist at the Daiwa Institute of Research, the fall in inflation is linked to the overall shrinking of food and energy prices. Fresh food prices declined 0.4% from August to an 8.8% annual increase.

Core inflation, which excludes volatile products like food and energy, declined even further in September at 2.8%.

“The momentum of price hikes has been receding through the second half of 2023,” said researcher Teikoku Databank, "as more companies have been able to pass on a certain amount of the sharply increased raw material prices of the previous year to their customers.”

Will the Bank of Japan raise interest rates?

So far, the Bank of Japan has observed closely the variations in inflation readings, although it has not taken any action so far.

Japan comes out of a decade of slow growth and stagnating economy. In order to stimulate GDP, the BoJ kept negative interest rates for years. Growing inflation means more people are buying goods and services, thereby growing the Japanese economy.

For this reason, the Bank of Japan is skeptical about interest rate hikes, even though they raised the Yield Curve Control(YCC) to increase returns on long-term bonds.

A former member of the BoJ’s board said on Wednesday that negative interest rates will be abandoned by the end of the year. Indeed, Japan is receiving pressure from its American and European peers whose inflation rate is steadily declining (though it started from a much higher peak).

However, September’s better-than-expected inflation reading might convince the Bank of Japan that low rates are the best strategy for now.

“Rather than a policy change within the year,” Shotaro Kogu said, “after next spring’s annual wage negotiations will be a likely time for a policy revision.”

Another thing to keep in mind is that Prime Minister Fumio Kushida is at its lowest level of popularity ever. A shrinking economy could worsen his political position.