Automatic easing
Policy headwinds are also abating: for the first time since 2013, both fiscal and
monetary policy are poised to turn stimulatory in 2017.
Monetary policy: Bo) pegs to zero
The Bo)’s transition to yield-curve targeting ensures that real yields will drop as inflation
picks up, implying that financial conditions will turn increasingly loose as the recovery progresses. There are good reasons to be cautiously optimistic: after all, despite a triple whammy of weak domestic demand, weak commodity prices, and a stronger yen, Japanese inflation measures are showing early signs of bottoming out (Chart 6).
We expect Japan-style core inflation (CPI ex fresh food) to trough in Q4 CY16, after which it should accelerate relatively quickly in the first two quarters of 2017 in response to 1) a recovery in crude oil prices, 2) a weaker yen (we assume USDJPY rebounds to 120 by the end of the year), and 3} stronger wage growth. This also implies stronger core-core inflation (CPI ex food & energy). We are bullish on all three factors and see CY17 core inflation running at an above-consensus 1.0% and 1.4% in CY18.
This is still short of the central bank’s 2% target (Chart 7). But we believe there will be little pressure to lower rates further, especially against the backdrop of a weakening yen and rising global yields. More broadly, things are moving in the right direction for the Bo). The private sector has been steadily re-leveraging, albeit gradually. Meanwhile, labor markets continue to tighten and wage growth is slowly improving: the 4-quarter moving average for hourly wages is now up to 1.2% y-o-y (Chart 8). With the labor market for lower-cost part-time workers nearing saturation, growth in higher-quality, full-time jobs is picking up (Chart 9). We expect a moderation in employment gains and
faster wage growth ahead.
Chart 6: Produce and consumer price inflation (ex-tax effect)
4 1.0 2 0.5 0 0.0 -2 0.5 4 -1.0 -6 -1.5
2011 2012 2013 2014 2015 2016
—— Corporate goods prices %YoY (LHS) ——Headline CPI %YoY (LHS) == Corporate service prices %YoY (RHS)
Source: BofA Merrill Lynch Global Research, MIA
Chart 8: Wage growth is picking up on the back of tight labor markets
Chart 7: Japan-style core inflation (CPI ex fresh food) forecasts (FY basis)
2.0 1.0 0.0 -1.0
-2.0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
BoJ BofAML
Consensus —= —= Target
Source: BofA Merrill Lynch Global Research, Bo), JCER *Consensus is JCER ESP survey
Chart 9: Full-time job growth is accelerating
2 1 0
' NR
2000 2002 2004 2006 2008 2010 2012 2014 2016
——Hourly wages, %YoY 4qtr ma
== US-style core inflation (ex-tax), %YoY 4qtr ma Source: BofA Merrill Lynch Global Research, MHLW, MIA
3.0 Abenomics 2.0 1.0 0.0 -1.0 -2.0 -3.0
2000 2002 2004 2006 2008 2010 20121 2014 2016
mae Part-time, ppt contribution moe Full-time, ppt contribution —— Total employment, %YoY
Source: BofA Merrill Lynch Global Research, MIA
Bankof America Merrill Lynch
Japan Economics Viewpoint | 18 November 2016 3
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