Core concern

AFTER two years of remission, Japan seems likely to sink back into the “chronic disease” of deflation, as Haruhiko Kuroda, the governor of the Bank of Japan (BoJ), calls it. New data are expected to show on August 28th that core CPI, the central bank’s preferred indicator of inflation, turned negative in July for the first time since the bank launched a big programme of quantitative easing (printing money to buy bonds) in April 2013 (see chart). At the time, it pledged to lift inflation to 2% in two years.

The news will heap further pressure on the BoJ to ease monetary policy yet more this year, as will worries about Chinese growth. The fact that Japan’s economy shrank by 1.6% in the second quarter on an annualised basis adds to the concerns. The central bank is currently buying about ¥80 trillion ($670 billion) of long-term Japanese government bonds (JGBs) a year, or twice the annual issuance. It now holds over ¥300 trillion of JGBs, or nearly a third of all outstanding bonds.

Mr Kuroda’s excuse for deflation’s apparent return is that the falling oil price has pushed down core CPI, which excludes fresh food but includes energy. In the longer run, the bank argues, consumers’ increased spending power will fuel inflation.

Mr Kuroda has already postponed the deadline for achieving inflation of 2% twice. The new deadline is next summer. But that now looks optimistic, and Mr Kuroda is hinting at another postponement. This week Shinzo Abe, the prime minister, said he understood the bank’s explanation that reaching the target of 2% “is in fact getting difficult”. But the bank is increasingly rattled by mounting criticism.

The side effects of monetary easing are under scrutiny, too. A weaker yen is seen by politicians in Mr Abe’s Liberal Democratic Party as benefiting big exporters but hurting small firms and households by raising the price of imports. Another worry is that the BoJ’s voracious bond-buying has impaired the functioning of the market for government bonds. Debt hawks complain—as ever—that the purchases are eroding the need for fiscal discipline on the part of the government.

The BoJ, for its part, remains confident that the economy is on the mend. It discreetly suggests that a big part of the problem lies with the inclusion of energy in its preferred measure of inflation. In July it quietly began publishing a novel measure in its monthly bulletins, which outsiders have dubbed “new core CPI”. This strips out the cost of energy as well as fresh food, and is rising by a relatively brisk 0.7%.

Some speculate that the bank may start to include new core CPI in its official forecasts. “We will never use the word ‘alter’ or ‘shift’,” says one person close to the bank. But the move is long overdue, and the sooner the bank makes it the better, says Christopher Wood of CLSA, a brokerage.

Yet depending on how the economy fares, even the new index may not keep rising. Measures of inflation expectations remain fairly stable for now, but may begin to fall if core CPI does indeed turn negative. That might prompt the BoJ to ease monetary policy by techniques other than bond-buying, such as adopting a negative interest rate for the excess reserves banks keep with it, or buying more exchange-traded funds. Such steps are unlikely to reduce the controversy surrounding the bank.