Japan central bank finds the pessimists come from within

TOKYO Fri Jul 26, 2013 4:17am IST

Shoppers walk inside a shopping mall in Tokyo July 25, 2013. REUTERS/Yuya Shino

Shoppers walk inside a shopping mall in Tokyo July 25, 2013.

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TOKYO (Reuters) - Some Bank of Japan policymakers are becoming more vocal in expressing concerns about the economic outlook, threatening to pick away at what has been a unified public position of optimism key to the central bank's reflationary message.

The three policymakers on the nine-member board see more risks than their colleagues from Japan's planned increase in a domestic sales tax in April, a contentious issue Prime Minister Shinzo Abe must deal with after his resounding election victory on Sunday.

They are also more concerned than the others about a slowdown in China's economic growth, which has become more apparent in recent months.

With the economy responding well to the Abenomics phenomenon of aggressive monetary policy, fiscal spending and the promise of economic reform, the pessimists see no imminent need for additional growth stimulus.

But their doubts may gain more traction next year once Japan feels the pinch of the sales tax hike and China's slowdown, and so undermine the BOJ's relatively upbeat message. The BOJ's economic forecasts project a stronger recovery than private analysts by some margin as the central bank targets turning years of deflation into 2 percent inflation in two years.

"There's no need to overly emphasize the external risks now with the economy so strong," said a source familiar with the central bank's policy discussions.

"Still, the pessimists have a point. Even the optimists aren't convinced that everything is on track. There's still a long way ahead to achieving 2 percent inflation."

The pessimists' concerns may also win over the board into taking stronger money market measures if government bond yields spike again, unlike in recent months when the central bank refused to be drawn into taking stronger measures as 10-year returns jumped to 1 percent from just 0.3 percent.

"We have a free hand and are completely open on what steps to take if tail risks or downside risks materialize," board member Takehiro Sato, among the pessimists, said on Monday in the strongest language yet voicing a readiness to act against adverse market moves.

NOT TOO ROSY

Emboldened by the strength in exports and consumer spending, the BOJ said this month that the economy was finally recovering, its most optimistic view in two-and-half years.

The next significant test of the economy's strength may come next April, when the government plans to raise the 5 percent sales tax to 8 percent. Under the plan, which Abe has yet to confirm, the sales tax will rise again in 2015 to 10 percent.

Many central bankers believe the economy can weather the tax hike and want the government to push ahead. A delay will cast doubt on the government's commitment to fix its tattered finances, they argue.

But BOJ policymaker Sayuri Shirai, a former IMF economist, frets the damage to household sentiment may be bigger than previous tax hikes in 1989 and 1997. Unlike in the past, consumer prices will be rising next year due to the BOJ's aggressive stimulus, so the tax hike will eat further into disposable income and raise the risk that households will cut spending sharply, she says.

Indeed, the BOJ expects the tax hike to push consumer prices up by 2 percentage points in the next fiscal year beginning April 2014, taking core consumer inflation to 3.3 percent - a level not seen for more than two decades.

The extent of the economic slowdown in China has added some credence to the pessimists' view in the BOJ. The Chinese economy has consistently underperformed expectations this year and Beijing has emphasized the need to push ahead with reforms, suggesting it has no plans to provide significant stimulus like it has done in the past.

The BOJ's baseline scenario is China's slowdown will not be a severe drag on the global economy, and that world growth will expand more strongly next year in time to make up for an expected drop in Japanese spending after the tax hike.

Minutes of the BOJ's policy meeting in June showed one board member warning of lingering uncertainty over the global economy that may delay a pickup in Japanese exports.

The minutes did not identify the board member, but analysts suspect it was former economist Takahide Kiuchi, given the pessimistic tone of his remarks in past public appearances.

Many BOJ officials already feel that overseas growth is not picking up as much as they had hoped anyhow. But since the domestic economy is doing so well, the external risks are less of a concern. If the strength of the domestic economy tapers though, the internal debate may change, they said.

"None of the risks warrant a big change in the BOJ's assessment that Japan is headed for a moderate recovery," said another source familiar with its thinking. "Still, there's no strong grounds to the projection that overseas economies will somehow pick up later this year."

The sources declined to be identified because they are not authorized to speak with the media.

Analysts polled by Reuters expect Japan's economic growth to slow down to 0.5 percent in the next fiscal year from 2.7 percent this year, mainly due to the impact of the higher sales tax.

That is far weaker than the BOJ board's median projection of 1.3 percent growth next business year, although its forecasts ranged from 0.4 percent to 1.5 percent.

Sato, who along with Kiuchi has publicly voiced skepticism over the BOJ's intention to achieve 2 percent inflation in two years, echoed the concerns.

"We should not expect China's growth rate to recover noticeably for the time being," he said on Monday in a speech to business leaders in northeastern Japan.

The BOJ faces a crucial test in February and March, when many Japanese companies start setting base salaries for their employees. That will determine if the BOJ has done enough to persuade corporate Japan that a brighter economic future lies ahead. Years of deflation mean that base wages have not increased since 2005.

Unless companies raise wages enough to at least match the sales tax hike, household income will decline, BOJ officials say. That could undermine the BOJ's stimulus program, which aims to achieve inflation sustained by wage growth and a healthy economic expansion.

The hit from the expected sales tax hike in April will also put the central bank under pressure to offer additional stimulus to keep the economy afloat, said Izuru Kato, chief economist at Totan Research Institute in Tokyo.

"The BOJ might put up a brave face but it doesn't have many policy options left," he said. "It may keep arguing that Japan will eventually see 2 percent inflation, but it's hard to keep saying so unless the economy expands more strongly."

(Editing by Neil Fullick)

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