Inflation jumps again in Japan but USD/JPY move has limits

JPY: Inflation drive BoJ real policy rate lower

The yen has corrected modestly stronger but remains sharply weaker this week, fuelled not just by US dollar strength but by the markets continuing to push back the timing of when the BoJ may alter its monetary stance. Real yields continue to be driven lower in Japan at a time when real yields in most other G10 countries have been moving higher. We are at the cusp now in the US where the real fed funds policy rate is moving into positive territory and over the coming months as CPI falls further in the US, that real policy rate will move further higher.

The opposite being the case in Japan was evident today with the release of the nationwide CPI data which revealed a pick-up in the core nationwide CPI annual rate from 3.1% to 3.4% in April. The annual rate has already declined following government subsidy measures that helped push down energy-related inflation. The annual core CPI rate peaked at 4.2% in January before falling back to 3.1% in February and March. The Tokyo data for April – already released – had indicated that inflation had begun to move higher again so that data is not a huge surprise. Nonetheless, the CPI data show clear intent of businesses’ willingness to pass increased costs onto consumers. The BoJ in its April Outlook for the Economy and Prices report showed a forecast of 2% for core CPI in FY2024 which certainly takes the BoJ closer to formally acknowledging that it has achieved its goal. But the FY25 inflation forecast is back at 1.6% and hence the justification for maintaining the current ultra-lose policy stance.

Excluding energy from the core nationwide CPI annual rate gives you the true underlying picture and on that measure annual CPI has continued to accelerate, reaching 4.1% - the first breach of the 4.0%-level since August 1981.  

In thirteen months, the core-core annual CPI rate has jumped from -0.7% to 4.1%. That’s a 4.8ppt move higher and the speed of the move is not too dissimilar to the speed of move in core CPI in the US. From February 2021 to March 2022, annual US core CPI accelerated by 5.2ppts. It’s taken 20mths in the euro-zone to see the core annual rate jump by 5.0ppts. The current mix of increased Fed monetary tightening speculation and still rising inflation in Japan and ultra-loose policy is fuel to the move higher in USD/JPY. While a shift in BoJ policy has been pushed back today’s data does still strengthen the case for a change in policy later in the year, so we maintain there are limits to this USD/JPY move higher and the window for a higher USD/JPY could close quite abruptly.

BOJ CLOSE TO RUNNING DEEPEST NEGATIVE REAL POLICY RATE

Source: Bloomberg & MUFG Research calculations (real rate deflated by core CPI)

EUR: The good news is priced as optimism fades

EUR/USD has broken lower and the technical picture certainly points to further near-term downside momentum. The trendline support from the lows in September and November of last year broke yesterday at 1.0775 and in addition the 200-day MAV at 1.0807 has also now been breached opening up the potential for further selling. While the dollar has strengthened more broadly on the back of debt ceiling fears receding and continued hawkish Fed rhetoric, the optimism in Europe is also fading somewhat.

One gauge we track that has a very strong co-movement with EUR/USD is the performance of cyclical stocks relative to the overall Euro Stoxx 600 index. After a period of strong outperformance, cyclical stocks are now underperforming again. Is this a reflection of bad news emerging or more a reflection of excessive optimism correcting back to a more realistic level? For now we would be in the latter camp with no real deterioration in the data or news flow to warrant a reassessment of the outlook.  

Indeed, the primary factor for a reassessment of the previous more negative economic outlook was the plunge in natural gas prices. That certainly hasn’t changed. The TTF natural gas 1mth forward contract broke below EUR 30 yesterday for the first time since June 2021. Our MUFG commodities analyst estimates that natural gas inventory inflows to reach the 90% capacity target for winter 2023-24 requires 25 billion cubic metres and to reach 100% capacity would require 33bcm. Looking back at last year’s refilling season and excluding Russian natural gas inflows, Europe managed 38bcm. So with storage capacity already at 55%, Europe is in a remarkably good position to ensure prices remain well contained.

With inflation set to fall further over the coming months, the prospects for euro-zone households remain much better. So we see no reason for a sustained deterioration in sentiment to warrant a more pronounced retracement of the EUR/USD move higher. Our EUR/USD year-end target of 1.1500-1.1600 is based on the Fed’s tightening cycle having ended this month and then the Fed cutting by year-end. Dallas Fed President Logan’s was very clear yesterday that the data to justify a pause in June wasn’t evident yet so certainly if the US rates market continues to price a greater probability of a June hike, then further dollar gains over the short-term are likely. So the potential for EUR/USD downside is certainly more from the dollar side than the euro.

CYCLICAL STOCK UNDERPERFORMANCE WEIGHS ON EUR

Source: Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	ECB Economic Bulletin				!
UK	10:45	BoE's Haskel speaks				!!
CA	13:30	Retail Sales MoM	Mar	-1.4%	-0.2%	!!
CA	13:30	Retail Sales Ex-Auto MoM	Mar	-0.8%	-0.7%	!!
US	13:45	Fed's Williams speaks				!!!
US	14:00	Fed's Bowman speaks				!!
EC	14:55	ECB's Schnabel speaks				!!
US	16:00	Fed Chair Powell speaks				!!!!
EC	16:00	ECB's Schnabel speaks				!!
EC	20:00	ECB President Lagarde speaks				!!!!

Source: Bloomberg