US October PMI 

Inflation in Tokyo slowed below 2% for the first time in five months largely due to energy prices, as the country heads into a general election and the Bank of Japan (BOJ) mulls data for its policy decision next week. 

Consumer prices excluding fresh food rose 1.8% in the capital in October, marking the second month of deceleration, the Ministry of Internal Affairs reported on Friday. The reading slightly exceeded economists’ estimates of 1.7%. Tokyo’s figures often serve as a leading indicator of national trends.

The slowdown was primarily driven by softer growth in energy prices. Government subsidies for energy costs shaved off 0.51 percentage point from the overall price index in October. 

Weaker price momentum, mainly driven by known technical factors, is unlikely to have a major impact on the BOJ’s upcoming policy decision. Officials see little need to rush into raising interest rates this month while they remain on track to hike at a later stage, according to sources familiar with the matter.  

“The impact of today’s results on BOJ policy appears neutral,” said Takuya Hoshino, the chief economist of Dai-ichi Life Research Institute Inc. “If prices were higher, it would have reinforced the BOJ’s view that the economy is on track, but that doesn’t seem to be the case.”

In the latest Bloomberg survey, almost all BOJ watchers see no move in October, with half expecting a rate hike in December. The board is set to announce the outcome of its two-day meeting next Thursday. 

A deeper price gauge that strips out energy prices rose to 1.8% in October from 1.6%, pointing to continued underlying inflationary momentum. Prices for a variety of items are typically revised at the start of the second half of the fiscal year in October. A Teikoku Databank survey suggests that 2,911 food items saw price increases in October, marking the highest number in a year. 

Service prices also rose 0.8% from a year before in October, up from 0.6%. This includes postal fees, as Japan Post Co raised rates for ordinary mail by 30% this month, the first increase in 30 years.

Sticky inflation may affect public sentiment, a key concern for Prime Minister Shigeru Ishiba and his Liberal Democratic Party as they head into a general election on Sunday. Local media reports suggest that there is a chance the ruling party will face its biggest loss since 2009. 

In an effort to raise his odds of success in the election, Ishiba has said there will be an extra budget that’s larger than last year to support those struggling with inflation, and to stimulate the broader economy. Still, he hasn’t provided details of specific measures, including whether utility subsidies will be extended through year end.

Wage negotiations for next year will also be affected by the pace of price gains. This year some Japanese workers secured the largest wage hike in 33 years at 5.1%, driven in part by companies’ desire to retain staff amid rising prices. For next year, Japan’s largest union federation Rengo announced plans last week to seek a 5% or more wage hike, maintaining this year’s target.  

Beyond the impact from price relief measures, the currency trend will remain a source of uncertainty for inflation. Amid stronger-than-expected US economic data, the yen traded around 152 to the dollar on Friday morning, after recently crossing the 150 threshold. This has partly led to Japan’s imports growing in value, adding pressure on households and businesses reliant on foreign energy and food.

Source: The edge markets

One of the frustrations of the post-GFC period was the way some people (and international agencies) assumed that historical averages of key ratios like housing prices or debt to income defined ‘normal’. If one of these macro ratios was well away from that historical average, it was an ‘imbalance’ that needed to be corrected, it was claimed.

The problem with this idea is that often the metric in question does not have a ‘right’ level that prevails through time. In the case of the economy-wide ratio of household debt to income, the sustainable ratio is higher in recent decades than it was back in the 1970s and 1980s. If inflation – and so nominal interest rates – falls permanently, the sustainable debt-to-income ratio rises, because households can service a larger loan with the same repayment. Financial deregulation also removed other artificial constraints on borrowing that prevailed back then.

This point has been well understood for more than 20 years, having been written about by various RBA staff members (including me) all those years ago. Yet still one hears concerned comments that once upon a time you could only borrow four times income, and now you can borrow a much higher multiple. And it’s true, because once upon a time inflation averaged 6–8% and mortgage rates were double-digit, but not anymore.

The misunderstanding was even more frustrating because, often, the historical averages used were based on data sets that went back to 1980. Since Australia was later to join the low-inflation club than many of its peers, more of the period since 1980 was in that high-inflation-low-debt era. That drags the historical average lower, making the recent data look higher in comparison than for other countries that already had inflation down by the early 1980s. That Australia looks ‘worse’ on these metrics is mainly a statistical artefact.

There is a broader point here: historical averages do not always represent centres of gravity to which the world must somehow return. Many of the metrics in question are emergent properties of the economic system and not bound to return to a particular number. We have made this point before, regarding the structure of interest rates globally and the sustainable level of the unemployment rate.

Part of the issue is that even if people behave similarly to the past, the macro-level averages and ratios that come out of that behaviour might not be the same as in the past. The composition of the population might have changed, or some other factor that changes the macro-level outcome. Certainly, the age structure of the population has changed. Population growth rates also do not stand still; in Australia, population growth has been noticeably faster post-GFC than pre-GFC. This has implications not only for labour market variables, but also things like the required rate of home-building each year.

Things aren’t the same after a shock

The question of where ‘normal’ is becomes especially salient when you are coming out of a large shock like a pandemic. It is tempting to look at the pre-pandemic period as the benchmark for where things are likely to return, but this is probably a mistake.

The reality is that the pre-pandemic period wasn’t ‘normal’ either. There was considerable labour market slack in Australia at the time. Wages growth consistently undershot RBA and other forecasts. Inflation lagged below target despite what appeared to be very expansionary monetary policy.

There was something going on beyond the national level, too. Many peer economies were finding that unemployment rates could decline to levels not seen in decades without wages growth or inflation picking up materially. Global rates and risk spreads were also far from normal, compressed to extreme levels. If someone had told me at the beginning of my career that large parts of the European corporate bond universe would have negative nominal yields for a sustained period, I would never have believed them.

Another decidedly non-normal feature of the period between the GFC and the pandemic was that business investment in many advanced economies (including Australia) lagged historical averages. So did trend productivity growth. These trends were probably related, with some researchers hypothesising that this was a consequence of the financial crisis, and the associated weak demand and debt overhangs.

The upshot is that the global economy had probably barely completed the adjustment to the previous big shock, the GFC, before being hit by the next one, the pandemic.

Make the trend your friend

How can you forecast, or even interpret current events, when the ground is shifting in this way?

One approach is to focus on the underlying behaviour at a more micro level and let the implications for macro variables flow from that. For example, forecasts of consumption are typically based on past experience of people’s spending responses to additional income. This approach won’t always predict actual outcomes: as Westpac Economics colleague, Economist Jameson Coombes reported yesterday, the recent data from the Westpac–DataX Consumer Panel is pointing to a smaller spending response to the Stage 3 tax cuts than the historically typical response. But it is better than playing chartist with macroeconomic ratios by assuming that consumption reverts to a ‘normal’ share of income.

It is also useful to factor in any longer-term trends that are in evidence. The trends in the labour market are a case in point. In addition to the stronger average population growth, the participation rate has been trending up for decades and this shows no signs of ending.

If population growth is stronger than it used to be in decades past, then employment growth needs to be higher to keep pace, too. And if the participation rate is trending up, employment growth needs to outpace working-age population growth to avoid rising unemployment. Some observers have interpreted recent rapid growth in employment as a sign that the labour market is still strong. But it could equally be viewed as being insufficient to keep pace with the even faster growth in labour supply.

It all depends on what your view of normal is.

[Quick Facts]

[News Details]

[Today's Focus]

Market Picture

The cryptocurrency market has been rising since the start of the day on Thursday, recovering strongly from Wednesday’s late afternoon sell-off in the wake of global financial markets. At its lowest point, the market capitalisation was down to $2.23 trillion, and at the time of writing, it had risen to $2.32 trillion (+0.1% in 24 hours). The market’s intraday movements will reveal whether this marks the bears’ last stand or if the current rebound is just a bull trap.

Bitcoin’s intraday dynamics are bullish. Wednesday’s end-of-day lows saw a flash drop below $65.5K, completing a 61.8% Fibonacci retracement of the 10-21 October rally. A quick exit to the recent highs at $69.5K would make the main scenario an extension of the upside with the potential to strengthen to $76K before further consolidation.

News Background

According to CryptoQuant, 94% of the Bitcoin supply is ‘long’, with the median purchase price hovering around $55K. Such high levels of unrealised profits have historically served as a precursor to significant BTC corrections.

Retail demand for Bitcoin returned to pre-ATH levels in March. This contrasts with the first quarter when large players largely drove demand.

Bernstein reiterated its prediction of a $200K price for the first cryptocurrency by the end of next year, calling it ‘conservative’. BTC’s investment appeal is increasing against the backdrop of rising US government debt and the threat of inflation.