BOJ may revise up CPI forecast but deflation to drag

The Bank of Japan could say this month that consumer prices will stop falling next fiscal year, sources say, but analysts said it would keep its easing bias as a full-fledged escape from deflation is still a distant goal.

That would mark an upgrade to the BOJ's current price forecast for the year to March 2012, sources familiar with thinking said.

Economists say that while this is achievable, price momentum won't be strong enough to signal a decisive end to deflation given the large gap between supply and demand.

The central bank has given slightly more positive views on the in recent weeks due to an export-driven recovery. The BOJ has also indicated it is open to further easing even as the economy improves because monetary policy would have a bigger impact.

The BOJ is faced with the delicate task of acknowledging improvements in the economy without giving the impression that it is ready to withdraw monetary easing. Still, one economist voiced concern that by raising its price forecast, the BOJ risked being misunderstood.

“If the BOJ upgrades this forecast they would be sending the wrong message to businesses and the foreign exchange market,” said Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors in Sydney.

“It might signal less inclination to take further easing. I'm concerned Japan hasn't done enough, because consumers and businesses are still operating with a deflation mentality.”

BOJ Governor Masaaki Shirakawa has said that the central bank would continue its efforts to beat deflation by maintaining its very loose monetary policy, but he gave no hints on whether additional easing measures were on the horizon.

Wholesale prices fell 1.3 percent in the year to March, the smallest drop in more than a year as falls narrowed for the seventh straight month, but this was largely due to rising energy and commodity costs, BOJ data showed.

Together with improvements in the economy, though, this may prompt the BOJ to revise up its consumer price forecast for the year to March 2012 in its twice-yearly outlook report due on April 30, sources said.

“Both wholesale and consumer prices are likely to stay on an upward bias in coming months,” said Junko Nishioka, chief Japan economist at RBS Securities.

“But this is unlikely to lead to a change in the Bank of Japan's loose monetary policy as the BOJ focuses on the price trend rather than short-term moves.”

The BOJ currently expects deflation to last for three years until March 2012. It will review that prediction as well as its economic growth forecasts in its twice-yearly outlook report.

It may lift its consumer price forecast for the year to March 2012 to zero change or slight positive growth from a 0.2 percent drop forecast three months ago, the sources said.

Still, that remains far below the one percent consumer inflation that Finance Minister Naoto Kan said he wanted to see, and roughly the level that the BOJ itself sees as signifying desirable price growth.

Analysts also say slack domestic demand will continue to put downward pressure on consumer prices.

Domestic final goods prices, a component of the wholesale price index that loosely tracks the consumer price index, fell 0.7 percent in the year to March after falling 0.8 percent in February.

Deflation can be damaging to an economy as consumers put off spending if they expect prices to keep falling, which can in turn discourage companies from increasing capital spending. Deflation can also discourage borrowing, because real interest rates are higher than nominal rates.

Speaking in parliament, Shirakawa repeated that he expects annual consumer price falls to narrow as the nation's output gap shrinks reflecting improvements in the economy.

He ruled out the possibility of the BOJ expanding its balance sheet through purchases of property or shares, when asked by a lawmaker whether that was an option.

At the BOJ's mid-March policy-setting meeting, many board members played up the effectiveness of extra monetary easing even as the economy recovers and deflation eases, the minutes of the meeting showed.

At that meeting, the BOJ eased policy by doubling to 20 trillion yen ($214.6bn) the funds available to banks for three-month loans at its policy rate of 0.1 percent, following a drumbeat of government pressure.

If the BOJ were to ease again, possible options could include further expanding the three-month loans or other money-market operations to bring down short-term lending rates, economists say.

The BOJ introduced the three-month funding scheme in December after the government declared Japan was in deflation and prodded the central bank to do more to fight price falls.

A solid recovery in exports to Asia has driven Japan's recovery since last year after it suffered its worst recession in many decades, but demand in Japan has remained weak except for stimulus-fuelled buying of durable goods, leaving prices under pressure.

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