Japan's Wholesale Inflation Slows, But Cost Pressures Keep BOJ Hike Expectations Alive

What happened

Japan's wholesale prices, as measured by the Corporate Goods Price Index (CGPI), rose 6.8% year-on-year in September, according to data released by the Bank of Japan (BOJ). While this figure was below the 7.6% forecast and August's 7.6% gain, it still represents an elevated level of inflation. On a monthly basis, prices fell 0.3%, contrary to expectations for a 0.5% rise and following a 0.2% decline in August.

Japanese companies continued to pass on higher fuel and chemical costs. A crucial factor was the yen-based import price index, which surged 24.5% year-on-year, demonstrating how the weakness of the Japanese currency continues to push up the cost of imported raw materials.

Why it matters

Despite the deceleration relative to expectations, annual wholesale inflation near 7% remains well above the BOJ's price targets. The details of the data point to persistent cost pressures throughout supply chains, with the yen's depreciation amplifying the impact of elevated oil prices and other commodities. A weak yen increases the cost of energy and feeds into pipeline inflation, which can eventually be passed on to consumer prices. The BOJ is expected to consider these factors when formulating its new quarterly growth and inflation forecasts at its upcoming policy meeting later this month.

Market impact

• Interest rates and bonds: Japanese government bond (JGB) yields tend to remain sensitive to any signals of a more restrictive monetary policy from the BOJ. The persistence of wholesale inflation, even if slightly below expectations, maintains pressure on the BOJ to consider monetary tightening, which could lead to an increase in JGB yields.
• Dollar and FX: The possibility of a BOJ rate hike, which would narrow the interest rate gap with other major central banks, could provide support for the yen. A stronger yen would alleviate imported inflationary pressure, which is one of the main arguments for earlier action by the BOJ. Should the BOJ signal or execute tightening, the yen tends to appreciate against the dollar.
• Equities: The Japanese stock market may react cautiously to signs of monetary tightening. While a stronger yen could be positive for purchasing power and inflation, higher borrowing costs could weigh on corporate profits, especially for highly indebted companies or those reliant on credit.
• Brazil: Indirectly, a stronger yen and tighter monetary policy in Japan could contribute to a global scenario of lower liquidity and increased risk aversion. This could, in theory, generate some capital outflow pressure from emerging markets like Brazil, although the direct impact is limited.

What to watch

Investors will be closely watching the BOJ's upcoming monetary policy meeting later this month, when the central bank will release its new growth and inflation forecasts. Any signaling or movement towards monetary tightening will be crucial. Furthermore, it will be important to observe whether companies continue to pass on higher costs to consumer prices, a factor the BOJ closely monitors to assess whether inflation is becoming entrenched.

Scenarios

Base Scenario: The BOJ maintains its ultra-loose stance for now but signals a higher likelihood of tightening in the near future, awaiting further data on consumer inflation and yen developments. JGB yields rise modestly, and the yen stabilizes. Risk Scenario: The BOJ surprises the market with a more hawkish signal or even a small rate hike, driven by persistent imported inflationary pressures and yen weakness. This would lead to a sharper rise in JGB yields and a more significant appreciation of the yen.

Original source: ForexLive (InvestingLive). For information only, not investment advice.