Japanese annual inflation hit a decade-high of 1.2 percent in March, helping trigger one of the biggest ever sell-offs in yen bonds as investors realized Japan has no immunity from price pressures facing the rest of the world, and that could eventually lead to a rate hike despite a weak economy.
Trading in bond futures on the Tokyo Stock Exchange was halted for a time to allow the market to settle, the first test of a circuit breaker mechanism introduced to the market this year.
Like other central banks, the Bank of Japan faces rising fuel, raw materials and food prices as it ponders what to do with rates, already at a very low 0.5 percent in Japan.
But because the increases in consumer prices in major economies are largely due to climbing costs, rather than strengthening demand, investors have until recently been eyeing more rate cuts, rather than hikes.
Japan's core inflation rate of 1.2 percent, issued on Friday, was just as economists had forecast but it reinforced the pressure on the BOJ to keep inflation under control, and shifted investors' focus towards an eventual rate hike.
"It is hard to think that the Bank of Japan's stance on monetary policy will change just because of a rise in cost-push inflation," said Mamoru Yamazaki, chief economist at RBS Securities.
"But it may stir talk among market players that it may become more difficult for the BOJ to lower interest rates."
BONDS HIT HARD
The yield on two-year Japanese government bonds the most sensitive to interest rate expectations, jumped to a six-month peak, with investors affected as much by rate expectations in the United States and other major economies as the outlook for Japan.
"The market is now moving on the view that the worst is behind us in the subprime-related woes, which is spurring a sharp reversal in positions that had bet on a bearish outlook on the economy and financial markets," said Yasuhiro Onakado, chief economist at Daiwa SB Investments, but he warned the market might go too far.
"As the markets settle from the sharp unwinding of positions tilted excessively towards such a bearish view, players will come to realize that time is needed to resolve the credit market problems and see the U.S. economy recover and see bonds as being oversold."
Swap contracts on the overnight call rate, the BOJ's key policy target, suggested a 25 percent chance of a BOJ rate hike by the end of the year.
Earlier this month, the contracts had been pointing to a 50-60 percent chance of a cut in rates this year.
The rise in Japan's core consumer price index, which excludes volatile fresh food prices but includes other food and oil products, marked the biggest annual rise since a 1.8 percent increase in 1998.
GOODBYE DEFLATION
After nearly a decade of deflation, Japanese consumer prices have finally set out on a clear rising trend in the past few months, with the pace of growth picking up since late last year.
But the price hikes, seen in household goods ranging from bread and milk to beer and noodles, have hurt consumer sentiment as wages remain stagnant -- raising stagflation fears.
"The price rises are being led by upward pressure from higher raw material costs and not by strong demand, so it is not a good pattern," Economics Minister Hiroko Ota told a news conference after a cabinet meeting.
Gasoline prices rose 19.0 percent in March from a year earlier, while that of heating oil rose 29.2 percent.
The so-called "core, core CPI", excluding prices of fresh food and oil products, rose 0.5 percent from a year earlier.
"What's happening now is price increases involving elements of deflation," said Takeshi Minami, chief economist at Norinchukin Research Institute, who stuck .
"Prices are being pushed up by raw materials costs but not by consumer demand, which will be a minus for both corporate profits and personal consumption. That will eventually put downward pressure on prices."
The Bank of Japan next reviews rates on Wednesday, with no change expected, but its twice-yearly outlook report on the economy and prices due at the same time will be closely watched.
The central bank downgraded its view on the nation's economy this month and said growth was slowing, dropping a reference to the economy expanding -- a phrase it had consistently used in its monthly report for nearly two years.
But BOJ Governor Masaaki Shirakawa said the world's second-largest economy would move back into a moderate expansionary trend near its potential growth rate, which central bankers see around 1.5 percent now.
"The rising CPI won't affect the Bank of Japan, which is focusing more on developments in subprime problems," Minami said.
"The next move will be a rate hike, but it won't happen until late next year, when the subprime mess is expected to settle to have Japan back on track for firm export-led growth."
Trading in bond futures on the Tokyo Stock Exchange was halted for a time to allow the market to settle, the first test of a circuit breaker mechanism introduced to the market this year.
Like other central banks, the Bank of Japan faces rising fuel, raw materials and food prices as it ponders what to do with rates, already at a very low 0.5 percent in Japan.
But because the increases in consumer prices in major economies are largely due to climbing costs, rather than strengthening demand, investors have until recently been eyeing more rate cuts, rather than hikes.
Japan's core inflation rate of 1.2 percent, issued on Friday, was just as economists had forecast but it reinforced the pressure on the BOJ to keep inflation under control, and shifted investors' focus towards an eventual rate hike.
"It is hard to think that the Bank of Japan's stance on monetary policy will change just because of a rise in cost-push inflation," said Mamoru Yamazaki, chief economist at RBS Securities.
"But it may stir talk among market players that it may become more difficult for the BOJ to lower interest rates."
BONDS HIT HARD
The yield on two-year Japanese government bonds the most sensitive to interest rate expectations, jumped to a six-month peak, with investors affected as much by rate expectations in the United States and other major economies as the outlook for Japan.
"The market is now moving on the view that the worst is behind us in the subprime-related woes, which is spurring a sharp reversal in positions that had bet on a bearish outlook on the economy and financial markets," said Yasuhiro Onakado, chief economist at Daiwa SB Investments, but he warned the market might go too far.
"As the markets settle from the sharp unwinding of positions tilted excessively towards such a bearish view, players will come to realize that time is needed to resolve the credit market problems and see the U.S. economy recover and see bonds as being oversold."
Swap contracts on the overnight call rate, the BOJ's key policy target, suggested a 25 percent chance of a BOJ rate hike by the end of the year.
Earlier this month, the contracts had been pointing to a 50-60 percent chance of a cut in rates this year.
The rise in Japan's core consumer price index, which excludes volatile fresh food prices but includes other food and oil products, marked the biggest annual rise since a 1.8 percent increase in 1998.
GOODBYE DEFLATION
After nearly a decade of deflation, Japanese consumer prices have finally set out on a clear rising trend in the past few months, with the pace of growth picking up since late last year.
But the price hikes, seen in household goods ranging from bread and milk to beer and noodles, have hurt consumer sentiment as wages remain stagnant -- raising stagflation fears.
"The price rises are being led by upward pressure from higher raw material costs and not by strong demand, so it is not a good pattern," Economics Minister Hiroko Ota told a news conference after a cabinet meeting.
Gasoline prices rose 19.0 percent in March from a year earlier, while that of heating oil rose 29.2 percent.
The so-called "core, core CPI", excluding prices of fresh food and oil products, rose 0.5 percent from a year earlier.
"What's happening now is price increases involving elements of deflation," said Takeshi Minami, chief economist at Norinchukin Research Institute, who stuck .
"Prices are being pushed up by raw materials costs but not by consumer demand, which will be a minus for both corporate profits and personal consumption. That will eventually put downward pressure on prices."
The Bank of Japan next reviews rates on Wednesday, with no change expected, but its twice-yearly outlook report on the economy and prices due at the same time will be closely watched.
The central bank downgraded its view on the nation's economy this month and said growth was slowing, dropping a reference to the economy expanding -- a phrase it had consistently used in its monthly report for nearly two years.
But BOJ Governor Masaaki Shirakawa said the world's second-largest economy would move back into a moderate expansionary trend near its potential growth rate, which central bankers see around 1.5 percent now.
"The rising CPI won't affect the Bank of Japan, which is focusing more on developments in subprime problems," Minami said.
"The next move will be a rate hike, but it won't happen until late next year, when the subprime mess is expected to settle to have Japan back on track for firm export-led growth."
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