BoJ policy outlook: Situation remains data dependent

From Jul-Sep, a sustained domestic recovery is expected, accompanied by an end to the deterioration in external demand, as a recovery in the US offsets the negative impact of a slowing China. In addition, with increasingly clear signals of wage growth even in small companies (29 or less employees in the Ministry of Health, Labor & Welfare's Monthly Labour Survey), reflecting the tight labor market, higher wages and service prices will likely gradually drive an improvement in inflation. Accordingly, the base case scenario is for the BoJ to maintain its current level of asset purchases, and does not factor in additional easing. 

That said, the BoJ continues to have an easing bias whereby it reserves the potential to ease further if it sees any signs that the economy or inflationary trend will undershoot its forecasts (or of insufficient improvement). Kuroda has repeatedly stated that he stands ready to "carry out any necessary adjustments after examining the risks." 

Jul-Sep and Oct-Dec should provide the answers as to whether the BoJ's upbeat forecasts are correct. The first key factor is whether the upbeat scenario on the economy is realized. The checkpoints will be whether the decline in exports stops, and whether the recovery in consumer spending appears to be broadening. 

The second key factor will be how far the recovery in wages will drive higher inflation, and particularly core-core (ex energy and food) inflation. The drag on inflation from the decline in energy prices should strengthen through Jul-Sep, before weakening from Oct-Dec. Inflation is expected to stay close to zero up to Jul-Sep, before improving from OctDec. How much inflation accelerates after Oct-Dec will depend on how far the core-core CPI improves. 

"While the upbeat scenario is our base case scenario, we see the outlook for monetary policy as remaining "data-dependent" for the time being," notes BofA Merrill Lynch.