Inflation in Japan has surprisingly – and significantly — soared. The Tokyo Consumer Price Index (CPI), a key measure of inflation, shows a year-over-year increase of 2.5%. More surprisingly, the core CPI, which excludes volatile food and energy prices, soared to a 6-month high. This development draws parallels to recent inflation spikes in the United States and the eurozone.
The unexpected rise in Japan’s inflation means the Bank of Japan has a real problem on its hands.
How can the Bank of Japan exit out of yield curve control and negative interest rates without sparking global upheaval when so much liquidity has come from investors borrowing at no cost in yen to fund risk-on investments everywhere else in the world?
Indeed, the BoJ has been contemplating reversing negative interest rates, despite Japan being in a recession right now. Persistent inflation could compel the central bank to take its first step toward monetary normalization. A possible initial step could be a move from -0.1% to 0%, followed by a pause. Governor Kazuo Ueda has reiterated the intention to maintain accommodative policies for a longer duration despite any initial normalization moves, but this could change very quickly.
What if whatever the Bank of Japan does isn’t enough? What if inflation accelerates further in Japan? And what happens to all those borrowed yen should there be a panic that forces the yen higher, sparking a reversal of the carry trade which has funded so much of the frothiness we see in large-cap tech stocks?
This goes beyond volatility. A seismic shift in Japan’s monetary policy can have several ripple effects that pose unpredictable consequences. The situation in Japan is significant not only for its domestic economy but also for global markets. Japan is the world’s third-largest economy, and its monetary policies and economic health have far-reaching implications. It could even spark a currency crisis.
As the BoJ contemplates its next steps, the balance between controlling inflation and supporting growth looks questionable. No central bank is later to monetary tightening than the Bank of Japan. If central bankers act too forcefully, they could cause a massive unwinding of leverage that their policies encouraged for decades. If they don’t act forcefully enough, Japan risks runaway inflation.
The bottom line is that no matter what happens, Japan poses great danger to global markets.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
