BoJ Preview: The Step of Faith

At the June 13-14 meeting, the BoJ will likely reduce their bond purchase by one trillion JPY to roughly five trillion JPY and hike by 10bps for short term interest rate. It is a close call between a June and July hike but on balance we are favoring a June hike. Labor cash earning has risen above 2%, along with the latest rebound in CPI, would be key factors considering in BoJ policy decision. BoJ had revised their inflation forecast for 2024 higher in April, citing accelerating wage growth will translate into higher inflation. While we agree that wage growth will drive inflation higher, our central forecast sees inflation to be lower than BoJ's forecast for we suspect Japanese residents will be unwilling to accept higher prices even when real wage approaches positive. Given the weak Q1 GDP and concern on consumption, our central forecast sees no more tightening for the rest of 2024.

The move is aligning with BoJ's assessment towards trend inflation and wages after 2024 CPI forecast was revised to 2.8% from 2.4% in April. Labor cash earning y/y rose above 2% to 2.1% in April as wage growth began to accelerate after the historic results from March's wage negotiation. Even if the average wage hike does not meet the historic sub five percent negotiate for large firms employees, a three to four percent wage growth would be sufficient to bring real wage to positive and stimulates consumption. However, Japanese residents are showing resistance to consume at higher prices and thus we believe the impact of wage growth towards inflation will be less than BoJ's expectation. Moreover, PPI continue to stay below 1% four months in a row, further reducing the impetus for business to raise prices.

In the latest comment from Ueda, he mentioned that "If underlying inflation moves as we project, we will adjust degree of monetary support" and "As we move towards exit from massive monetary stimulus, it would be appropriate to reduce bond purchases: It suggest that rate hikes and bond purchase reduction are in BoJ's consideration, echoed by Nakamura, a known dove. Forward guidance from the BoJ has its credibility significantly tarnished after multiple surprises but so far the surprise lies in action, rather than inaction. Such rhetoric reinforce the possibility of action in the June meeting.

Our central forecast sees inflation to flare up from wage hikes by a smaller magnitude than BoJ's own forecast and thus expects only one hike of 0.1% in June 2024. Although further tightening cannot be ruled out if wage-inflation translation turns up, the probability is low on consumers' reluctance in higher price and business inability to sustainably hike wages in the coming year.