Surging inflation won’t last

Headline inflation shot up to 3.7% y/y in October, the strongest since December 1990 while inflation excluding fresh food and energy rose from 1.8% to 2.5%. Although this puts inflation well above the Bank of Japan’s target, the case for tightening is weak, for three reasons. First, October’s inflation rate was probably the peak. “Core” goods inflation has run ahead of the PMI manufacturing output price index and is more likely to fall than rise further from here. Second, the economy is on shaky footing, as shown by the surprise GDP contraction in Q3. There’s a chance that the technical recession that we’re expecting in H1 2023 may have already begun. Third, the government’s supplementary budget aimed at dampening inflation should on its own suffice to bring inflation back below the Bank’s 2% target by Q2 2023. The spending measures are set to expire in September but easing commodity prices and a stronger yen should keep inflation below 2% through 2023 and beyond.