James Smith, Economist at ING, suggests that the Bank of Japan’s favoured core CPI measure looks set to peak around its current level (1.3%), which is bad news for the BoJ and its quest for 2% inflation. Key Quotes “January’s CPI data, due on Friday morning (0030 CET), looks set to show that prices remained flat on an annual comparison (previously 0.2%). This series closely mirrors the Tokyo CPI, which is released one month ahead of the national data and showed a similar decline in January. As is the case globally, the low headline figure is largely attributable to the plunge in energy prices, an effect which is likely cap overall inflation at around 0% for at least the first half of this year. With this in mind, the focus will remain firmly on the BoJ’s preferred core measure of inflation, which has trended upwards to its current level (1.3%). However, most of this inflation is “imported” and is largely attributable to JPY depreciation during 2014. Accounting for a lag of roughly six months, this effect should filter out of the annual comparison over the coming months. Indeed, with the nominal effective exchange rate 8-9% stronger than this time a year ago, we expect the core rate of inflation to move back down towards (or even below) 1% by the end of the year. This is bad news for the BoJ in its quest for 2% inflation, particularly given that inflation expectations also appear to be falling. This process is set to continue, given that consumers expectations are broadly led by anticipated changes in food prices, which is closely linked to the exchange rate (given that around 60% of food is imported). This will place further pressure on the BoJ to add stimulus over the coming months. That said, the BoJ is currently facing the problem of “damned if you do, damned if you don’t”. On the one hand, the introduction of negative rates have done little to reverse the trend towards a stronger Yen and a further rate cut in March is unlikely to fare any better. If anything, the move by the BoJ in January provided a wake-up call to markets about the limits of monetary policy. On the other hand, if markets start pricing in further action, the adverse reaction to an under-delivery could be fairly sizable. Ultimately, we think that the BoJ’s decision will largely depend on what the ECB delivers at its meeting a few days earlier. Unless the ECB chooses to go over and beyond what the market is expecting and barring an increase in global volatility, the BoJ’s preference may well be to remain on hold and see how the impact of negative rates evolves. But, as was the case in January, the near-term monetary policy outlook remains very uncertain.” For more information, read our latest forex news.