May 1, 2014 12:34 am JST

BOJ sees 2% price growth continuing -- but don't say taper

ISAYA SHIMIZU, Nikkei senior staff writer

The BOJ assumes that the Japanese economy will get over the shock of the April 1 consumption tax hike.

TOKYO -- For the first time since embarking on a bold new course of monetary easing, Japan's central bank has forecast two straight years of the roughly 2% consumer price growth it has set out to achieve.

     The Bank of Japan reckons prices will rise at about that rate in fiscal 2015 and 2016, according to its latest Outlook for Economic Activity and Prices, released Wednesday.

     But even two years of 2% inflation would not necessarily achieve the stability that the BOJ made a precondition for winding down quantitative and qualitative easing (QQE), a senior bank official said.

     BOJ Gov. Haruhiko Kuroda sought to nix any concerns over a Japanese taper.

     "It would be premature to determine the timing of an exit from easing based on the current outlook," he told a news conference.

     That he did so gives a glimpse into the tightrope walk that the bank's policy board faces. The price growth forecasts themselves are calculated to put upward pressure on prices by heightening inflation expectations. But the BOJ does not want financial markets to start pricing in the withdrawal of monetary stimulus yet, which could drive up long-term interest rates and produce other counterproductive effects.

     Japan's core consumer price index, which excludes perishable foods, climbed 0.8% in the fiscal year ended March 31. Stripping away the effect of the April 1 consumption tax hike, the BOJ is forecasting median price growth of 1.3% in the current year, 1.9% in fiscal 2015 and 2.1% in fiscal 2016.

     The BOJ is assuming that the Japanese economy will get over the shock of the tax hike and that disappointingly sluggish export growth will perk up. The economy should expand faster than its potential growth rate from fiscal 2014 to fiscal 2016, even allowing for the fluctuations in consumer demand caused by the recent tax increase and another planned for next year, Kuroda told reporters.

     To many in the financial markets, the BOJ's estimates look rosy. Private-sector economists see consumer prices rising at around 1% in fiscal 2014 and 2015, according to the Japan Center for Economic Research's ESP Forecast survey. But since the BOJ is trying to influence expectations about prices, not just predict them, it is no doubt prepared for such criticism. And as Kuroda made clear at his news conference, the bank is ready to deploy additional monetary support if needed.

     But the BOJ had another concern over its report: the possibility that market participants would see an exit from QQE on the horizon.

     Aiming for 2% price growth, the central bank has promised to continue quantitative easing "as long as it is necessary for maintaining that target in a stable manner." Back in April 2013, when it unveiled QQE, Kuroda told reporters that inflation may not need to reach 2% for the BOJ to determine that no further easing is required -- just being certain that the conditions are there could be enough.

     What constitutes a stable manner, a senior BOJ official says, is not how long price growth stays at 2% but the mechanism keeping it there. Specifically, people's expected rate of inflation needs to stick at around 2%, and that level of price growth must be sustainable even assuming supply and demand are in perfect balance, according to the official.

     Judging by the BOJ's latest estimates, these conditions will not be present in fiscal 2016. Gross domestic product is forecast to expand by 1.3% in real terms. But the economy's potential growth rate, while faster than the current 0.5% or so, is expected to remain below 1%. So in the bank's eyes, the exit is not yet in sight.

     Whether everyone else sees it that way will depend on how well the BOJ communicates its policy. And there is a risk to trying to have the best of both worlds by stoking inflation expectations while banishing the thought of tapering.