Tokyo CPI inflation slips back on food prices

Chris Scicluna
Emily Nicol

BoJ Tankan reports rise in firms’ medium-term inflation expectations close to target
As ever, the BoJ’s Tankan survey provided plenty of insights into current economic conditions and the outlook for growth (spoiler for the detail below: most firms appear to see growth as underwhelming and see little improvement in Q3). But with the rest of the major economies in the midst of a “new normal” of high inflation and rapidly rising interest rates – and non-negligible doubts about the sustainability of the BoJ’s current policy framework – most interesting this time around was the detail on inflation expectations. Strikingly, but perhaps not surprisingly, the Tankan showed that firms have increased significantly their expectations of inflation over coming years – and indeed by such an extent as to support the case for the BoJ to plot an exit from its current monetary policy settings should Kuroda wish to follow other central banks down that route before pressures on the yen and his 10Y yield target re-intensify.

Most notably, on average, Japanese firms now expect “general inflation” to be 2.0% in three years’ time (an upwards revision of 0.4ppt from the last Tankan survey), and still some 1.9% in five years’ time (an upwards revision of 0.3ppt) – suggesting that they now expect the BoJ’s 2% inflation target to be as good as met on a sustained basis over the medium term. Evidence of that nature has been used over past quarters by the other major central banks to revise up their medium-term inflation forecasts and thus justify monetary policy normalisation. And so, today’s Tankan results arguably provide BoJ Governor Kuroda with ammunition to do likewise at the July monetary policy meeting should he wish to.

Of course, the evidence on inflation expectations is not watertight. Indeed, while small firms expect inflation to be above 2% in five years’ time, large firms (manufacturers and non-manufacturers alike) expect it to be just 1.3% (still, however, a series high). In addition, firms still expect their own prices to rise significantly less than general inflation over the coming five years – e.g. large firms expect a cumulative increase in their output prices of just 2½% over that period. And while firms appeared to be more willing to pass on costs to customers – and by the most since the 1970s - they still see input costs rising significantly faster than their own selling prices.

Tokyo CPI inflation slips back on food prices; core measures edge higher but remain well below levels consistent with the BoJ’s targets
Contrary to expectations of a further rise, headline Tokyo CPI inflation edged down 0.1ppt in June to 2.3%Y/Y. However, that decline reflected a softer pace of increase of food inflation, down 0.5ppt to 3.9%Y/Y, with fresh food inflation much softer than in May. And given a further significant rise in inflation of household goods (up 1.2ppt to 4.3%Y/Y), the various core inflation measures all picked up further. In particular, the BoJ’s forecast inflation measure (ex fresh food) rose 0.2ppt to 2.1%Y/Y, while its preferred core measure (ex fresh food and energy) rose 0.1ppt to 1.0%Y/Y. And the internationally core measure (ex all food and energy) rose 0.1ppt to (an admittedly still very low) 0.4%Y/Y.

Tankan flags improved services sentiment in Q2, but ongoing manufacturing challenges; and outlook for Q3 looks underwhelming
In terms of the Tankan’s headline sentiment indices, the survey painted a mixed picture of current conditions, signalling a predictable rebound in services as domestic restrictions lifted but persisting challenges in manufacturing as the impact of China’s Covid shutdowns, Ukraine war and cost pressures took their toll. Certainly, the decline in the headline diffusion index (DI) for large manufacturers in Q2 was larger than had been expected, down a further 5pts to 9, a five-quarter low. While the weakness was broad-based, the most notable declines were recorded in sectors that had seen a significant surge in input cost pressures – i.e. iron/steel, lumber/wood – and those more acutely impacted by supply bottlenecks – i.e. autos and general machinery. And not least reflecting concerns about the global economic outlook – including US and European recession risks – manufacturers were anticipating only a modest improvement in conditions in Q3 (the DI was forecast to rise just 1pt to 10). We note, however, that the survey’s assumption for the yen exchange rate looks far too conservative at ¥118.96 for the current fiscal year, compared to the current spot rate above ¥135 – the weaker yen should provide scope for positive news on export earnings, notwithstanding the associated magnification of imported cost pressures.

Sentiment among services firms, meanwhile, was inevitably given a boost by the relaxations of restrictions last quarter. The headline non-manufacturing DI rose 4pts to 13, a new pandemic high, albeit still some 7pts off the level in Q419. The largest gains were seen in consumer-facing industries, although firms in hospitality were on balance still extremely pessimistic about conditions – indeed, despite rising 32ppts in Q2, at -31 it was still well below the long-run average (+1). But firms expected little improvement in sentiment this quarter, with SMEs in the sector anticipating them to worsen as price pressures were expected to mount. So, overall, the Tankan’s DI for all industries flagged only a tepid recovery in Q2 – rising 2pt to just +2 – with this forecast to reverse in Q3 and therefore remain well below the pre-pandemic five-year average (10).

Despite the uncertain outlook ahead, firms continued to expect solid sales growth in the current fiscal year, with the forecast for all firms having broadly doubled from the previous estimate to 4.3%Y/Y. But likely reflecting persisting price pressures, firms still expected profits to be down on the previous fiscal year (-3.6%Y/Y). As such, it was perhaps somewhat surprising to see that firms boosted their already strong capex intentions this year. Indeed, large firms were forecasting an increase of 18.6%Y/Y, although this coincided with a marked downwards revision in last year’s capex (down 7.7ppts to -2.3%Y/Y). And small firms planned to cut capital spending this year. Of course, improved capex plans might well reflect the ongoing need to address labour shortages, with the Tankan suggesting that firms of all size and across manufacturing and services sectors alike signalled insufficient staffing levels over the past quarter.

Japanese labour market numbers softer than expected, likely reflecting random volatility
Admittedly, today’s monthly labour market numbers came in on the soft side, with employment declining 140k in May. And with the number of people dropping out the labour force down a smaller 40k, this left the unemployment rate ticking 0.1ppt higher to 2.6%. This was still ½ppt lower than the post-pandemic peak. But it likely reflected a dose of random monthly volatility, with employment having risen by a cumulative 450k in the previous two months. Certainly, there was another solid increase in the number of job vacancies in May (1.9%M/M), to the highest level since the onset of the pandemic. And so the job-to-applicant ratio edged higher to 1.24x, the highest since April 2020, albeit still some way below the 12-month average ahead of the pandemic (1.60x).

Euro are flash inflation estimates set to rise to new record high in June despite temporary drop in Germany
The most notable release from the euro area today, will be the flash June inflation estimates. Despite the unexpected (but likely just temporary) fall in German inflation, in the absence of a significant surprise to the Italian figures (forecast to rise 0.6ppt to 7.9%Y/Y), we forecast headline HICP inflation to rise 0.4ppt to a new series high of 8.5%Y/Y due principally to higher energy and food prices. But while services inflation will have been negatively impacted by Germany’s discounted travel pass, we expect core inflation to edge very slightly higher to 3.9%Y/Y, similarly a series high.

However, today’s final release of the euro area manufacturing PMIs should confirm a decline in the survey’s output price PMI to a six-month low, suggesting a slight softening of price pressures from the sector. This in part likely reflects firms’ response to weakening demand, while the drop of more than 2pts in the manufacturing output PMI to a contractionary 49.3 and a very weak signal on new orders is also likely to add to evidence that industrial production has shifted into reverse gear for the first time since June 2020. While the flash survey suggested some further easing of supply disruption, with delivery times having lengthened the least since the end of 2020, constraints still remain acute in certain sectors, particularly autos. And these challenges are likely to be reflected in the latest new car registrations figures for June from France, Italy and Spain.

US manufacturing ISM and construction spending data to be watched for weakness
The week’s US dataflow concludes with the June ISM manufacturing survey and May construction spending data. The ISM survey is likely to suggest a slowing in activity in the sector, with our colleagues in Daiwa America expecting the headline index to drop a little more than 1pt to 55.0 – well down on recent highs but respectable nonetheless. Concerns about recession risks might be evident in the detail of items such as new orders, although prices paid are expected to remain elevated. Contrary to the consensus forecast, our colleagues predict a first decline in construction spending this year reflecting the likelihood of softer residential activity and perhaps a weakening of business investment too amid heightened economic uncertainty.

UK bank lending numbers and final manufacturing PMIs due
Like elsewhere, today will bring the final release of the UK’s manufacturing PMIs for June, which are expected to confirm the flash report, which showed a drop in the output PMI fell 0.4pt to a fifteen-month low of 51.2, while the new orders component fell to a contractionary 49.6, the lowest since January 2021. This morning will also offer an update on bank lending in May, with demand for new consumer credit likely to have remained subdued amid rising interest rates and diminished willingness to spend. Mortgage lending, however, is expected to have remained firm. 

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