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Japan's low-inflation puzzle unlikely to sway BOJ into action

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09/14/2017 | 09:37am CET
A man looks at a mobile phone in front of the Bank of Japan building in Tokyo

Japan is in the middle of a solid economic recovery, with business confidence at a decade-high. But inflation remains stubbornly low.

Sounds familiar?

The Bank of Japan, having tried many tricks in its monetary policy play book to vanquish decades of falling consumer prices, is expected to stand pat next week and signal that no further stimulus is forthcoming.

The nine-member board will likely debate why inflation remains puzzlingly low. While that question has been a perennial one for Japan, the mystery this time is that prices remain tame even as job availability hit a 43-year high and consumption has rebounded.

Given the slow inflation, some policymakers already worry that the BOJ may have to cut its inflation forecasts again at a quarterly review of its projections in October, say sources familiar with the bank's thinking.

"It's too early to think about new projections. But it's true inflation remains lacklustre despite pretty strong economic growth," said one of the sources.

Low inflation is a global phenomenon, including in many parts of Asia, Europe and the United States. In Japan, the problem has persisted since the late 1990s.

At the two-day rate review ending on Sept. 21, the BOJ is set to keep intact a pledge to guide short-term interest rates at minus 0.1 percent and the 10-year government bond yield around zero percent under its yield curve control (YCC) policy.

It is also seen maintaining a loose pledge to keep buying bonds so its holdings increase at an annual pace of 80 trillion yen (548.23 billion pounds).

The BOJ has actually slowed purchases as strong demand for bonds briefly drove down 10-year bond yields below zero percent. Maintaining the current pace of buying would see the BOJ purchasing around 60 trillion yen per year.

But central bank officials say they have no plan to change or remove the pledge as the BOJ may be forced to accelerate buying again if external factors send yields spiking.

In a post-meeting briefing, BOJ Governor Haruhiko Kuroda is likely to stress the bank is in no rush to follow the footsteps of its U.S. and European counterparts in dialing back stimulus.

Japan's economy expanded at an annualised rate of 2.5 percent in the second quarter thanks to robust exports and a pick-up in consumption. A recent survey showed manufacturers' confidence at a decade-high.

But core consumer prices rose just 0.5 percent in July from a year earlier, well below the BOJ's 2 percent target, as firms remain wary of scaring away households with price hikes.

The central bank cut its price forecasts in July and now expects inflation to hit 1.1 percent in the year ending in March 2018, still exceeding a 0.6 percent rise projected in a Reuters poll.

Some BOJ officials concede that another cut in the forecast may be inevitable at the October review, but add that any such downgrade would not trigger additional easing.

In an analysis in July, the BOJ partly blamed weak inflation on companies' efforts to streamline operations to meet labour shortages, such as automating operations with new machinery.

"Such efforts would boost productivity and won't necessarily be bad for the economy," justifying standing pat on policy even if inflation remains subdued, another source said.

The BOJ has had to push back the timing for reaching its price target six times since it deployed its massive stimulus programme in 2013. It now expects consumer inflation to hit its target by March 2020.

(Editing by Shri Navaratnam)

By Leika Kihara

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