Most of the rise in Japan’s inflation is due to food and energy prices. Despite an aggressive balance-sheet expansion effort, the BOJ has missed its target by a long shot. It appears to have all but given up on achieving 2% core inflation (excludes fresh food). After the March CPI was released at the end of last week, the BOJ surprised the markets by tapering the amount of bonds it was buying. This does not seem like a central bank that is about to ease policy.
Free education for young children and lower mobile phone charges will likely weigh on headline and core measures of inflation later this year. Another disinflation thrust will also emanate from the sales tax hike that the Abe government is still committed to despite the economic weakness. The government has already approved measures that are aimed at offsetting some of the initial impact of the sales tax increase, which in the past has triggered an economic contraction.
Monetary policy does not appear to be able to do more in Japan. The explosion of the central bank’s balance sheet does not appear to have had much impact on inflation or inflation expectations. The negative 10 bp deposit rate could be reduced further, but to what effect? There seems little correlation between inflation the extent of negative rates.
The House of Commons returns this week and with it, the Brexit drama. Previously, it seemed sterling would rise on indications that would encourage ideas of a softer exit and would sell-off on increased prospects of a harder exit. However, this pattern appears to have broken down. In the options market, implied volatility has fallen while the put premium over calls has fallen sharply. This is consistent with the sale of puts in the options market.
The uncertainty that hangs over Brexit seems to discourage speculative attention. The recent string of economic data would have likely fueled rate hike expectations if it weren’t for the risks associated with Brexit. Sterling finished last week below $1.30 for the first time in a couple of months. It is struggling to regain a foothold in holiday-thinned markets today. With Prime Minister May apparently being threatened to resign or that party will change the rules to try to force her out may renew the prospect of a more hardline candidate, like Johnson, replacing her, which would raise the specter of a no-deal exit again.