Payden & Rygel: Japan - inflation and rate hikes
To hike or not to hike in the face of an energy price shock—that is the question that markets and policymakers alike continue to ask.
Debating the first-round effects of the current oil supply shock on prices is one thing, but the challenge is how firms and consumers react to the shock through their future price expectations (so-called second-round effects). Unanchored inflation expectations are a policymaker's worst fear, and rightly so, as they can turn a transitory price shock into a persistent inflation problem.
While most central banks have held rates steady since March, they can continue to do so only if inflation expectations remain well anchored. So far, so good in the U.S., with long-term inflation expectations barely budging year-to-date.
But Japan may not be so fortunate. In fact, long-term market-based inflation expectations have risen rapidly, eclipsing the Bank of Japan's (BoJ's) 2% target. As BoJ Governor Ueda stated this week, 'if the markets perceive that there is a possibility that the [BoJ] might not take appropriate measures to address higher prices, this could be reflected in a rise in long-term interest rates" and "inflict a heavy burden not only on the economy but also on the financial markets.'
In other words, a hike in June is highly likely.