FX Daily: Japan’s Sales Tax increase hides declines in underlying inflation readings

27th June 2014

  • US Fed President Bullard said Thursday that preserving the end of the central bank’s securities reinvestment beyond the final exit from its unprecedented bond-buying program would be a useful devise for signalling a coming interest rate increase (MNI)
  • Fed’s Bullard, speaking Thursday, said that as credit markets heal, its harder to justify continued low rates. The St. Louis Fed Reserve President warned that if the unemployment rate falls faster than expected, Fed may be behind the curve and caution that we are no longer in a 1-2% low inflation environment. (Reuters)
  • Despite a surge in primary issuance, secondary trading volumes in Emerging Markets bonds have declined, causing concerns of a disorderly sell-off when the Fed starts raising rates. (The FT)
  • Greece’s government is set to reassess certain key tax collection measures which have been implemented over the past four years but failed to produce the expected revenues, a top Fin Ministry Official said Thursday. (MNI)
  • The PBOC does not need to resume reverse repos as money markets liquidity is stable at the end of June. The central bank suspended open market operations on Thursday and large banks also lent funds in the market to meet short-term fund demands. (China Securities Journal)
  • Zhang Monan, a researcher with the China Centre for International Economic Exchange, suggested China deepen financial cooperation with Europe. One idea is to develop a yuan bond market to ensure a stable supply of yuan funds. (China Securities Journal)
  • Foreign buyers may have added to the net housing demand in Australia but it is difficult to know the extent of demand increase and how much it has contributed to price rises, according to RBA’s Kent. (MNI)
  • Japan May Jobless Rate fell to 3.5% versus previous and expected level of 3.6%.
  • Japan May Household Spending fell -8.0% on the year versus median forecast of -2.0%, in its second straight y/y drop.
  • Japan Natl. CPI rose again to 3.7% from 3.4% in May. However adjusting for the sales tax increase underlying inflation was a mere 1.4%.

Reported real money sales got in on the USDJPY sell off this morning, sparked by a weaker Nikkei close in the Asian session and perpetuated by fundamental data this morning. The rate hit a one month low of Y101.32, and this time yen strength was played through the dollar-yen cross as opposed to euro-yen. There was further evident that Japan was weathering the first sales tax hike relatively unscathed. May monthly retail sales snapped back to a 4.6% gain, beating estimates for a 2.9% increase. The fall-off in May was downgraded marginally to -13.6% from -13.7%. The driving force behind USDJPY remains the will they or won’t they debate on further BoJ easing. The market’s indecision on this issue explains why it is USDJPY is now correlated with a straight line. However markets increasingly seem to be coming to the conclusion that the BoJ won’t increase the QQE target. I would argue that this morning’s other data releases increase the chances that the BoJ will be forced to act. Overall household spending declined 8.0% on the year in May, and while the fall in household income eased in May, a -4.6% annual decline is still a worrying figure. The April sales tax hike came at an opportune moment to skew the CPI read and pushed national inflation to 3.7%, its highest level in 13 years. Abstracting for the effects of the sales tax hike, inflation would have been 1.4%, a fall from March’s reading of 1.6% before the sales tax was introduced. This highlights a worrying downtrend in import price inflation since January. The impact of the past depreciation in the currency is falling out of the annual calculation. There is a simply mathematical truth here. In order to achieve a constant rate of growth, you need to add an increasing amount in nominal terms. The BoJ has a problem. They need robust consumption demand and inflation expectations to create demand pull inflation or they need the currency to weak further most likely via increasing asset purchases. Given the lack of impact Abe’s third arrow of reforms have had, we expect the BoJ to be forced into upping their QQE target by year end or at the start of 2015. In a recent speech, Kuroda reaffirmed the BoJ’s commitment to achieving its inflation target even if the potential growth rate was not improved via reforms. The BoJ has come too far and its balance sheet is to extended to turn back now.

All eyes today will be on the Germany CPI print today as a prelude to Monday’s first estimate of Eurozone June inflation. Spanish June CPI already fell marginally to just 0.1%, and 0.0% in the EU harmonised edition. Saxony released the first regional German estimate and showed a slight increase on the month at 0.9% YoY versus 0.8% in May. Food and energy continue to be the largest factors depressing price growth. A stronger euro may also be exaggerating their effect. However leisure and entertainment prices are on the rebound and we may see a revival in domestic demand supporting price growth. Air transport costs were also a positive contributor. Germany CPI is expected to increase slightly to 1.0% from 0.9% and Eurozone inflation to remain unchanged at 0.5% At this stage the ECB is still working through plan A, B, C and D to fight disinflation. They still have to wait to see the impact of these measures with a key focus on the take up for the first TLTRO in September. We also need to hear more details on the Asset Backed Securities Programme and see it implemented. Outright QE is the ECB’s plan Z. We have a long list of policy options and numerous more acronyms to delve into before we ever get ECB’s QE. While Eurozone CPI will undoubtedly drive currency markets, the ECB is focused not on outright inflation rates but inflation expectations. It would severe de-anchoring of market inflation expectations for the ECB to skip all the way to Plan Z.