Rise in services prices has also slowed down

The June CPI (Consumer Price Index) released by the U.S. Department of Labor on July 12 ended up being lower than expected. While the actual figure was not far-off from expectations, the bond and foreign exchange markets had strong reactions to the news, marking a return of “CPI Shock”—which happens when the CPI data provokes a substantial response in financial markets.

The June CPI was up 0.2% month-on-month, and the core CPI excluding food and energy was likewise 0.2% higher. Each of these fell short of expectations by about 0.1 percentage point. The year-on-year rate of increase in the total CPI was +3.0%, showing that inflation has fallen for 12 consecutive months to hit its lowest level in two years and three months. Based on the total CPI in June, it seems that we are witnessing a “U.S.-Japan reversal” whereby inflation in the U.S. falls lower than that in Japan. In addition, the core CPI in June was 4.8% higher year-on-year, falling to the level last seen at the end of 2021.

Used vehicle prices in June were down 0.5% from the month before. The core goods figure excluding food and energy was 0.1% lower than in May as well, marking the first such decline since December 2022. Looking just at data for goods, we see that the U.S. is experiencing deflation. The core services figure excluding food and energy was up 0.3% month-on-month, staying on an uptrend, but this was a smaller increase from the 0.4% rise seen in May. The rate peaked at the 0.6% increase seen in February, with the pace of that climb having slowed down since then. And although the rise in services prices has remained at high levels on account of high wage inflation, that trend has also begun to steadily slow down.

Medium-to-long-term inflation expectations have stabilized, aiding the recovery of price stability

As a result of the large-scale rate hikes by the U.S. Federal Reserve, medium-to-long-term inflation expectations in financial markets and among households in the U.S. have been kept relatively low. This will likely bolster the recovery of price stability going forward (Column: “Are Historic Price Surges Showing Signs of Ending?”, Jul. 6, 2023). 

During the price surges that occurred between 1970 and 1984 when inflation was high, it took around three years on average for the inflation rates in major economies to revert to their pre-surge levels after peaking on a year-on-year basis. The U.S. CPI hit its peak last summer year-on-year in terms of both the total and core figures. In light of the foregoing, it seems quite possible that the pace of increase in the CPI will need around another two years to get back to the level seen before prices skyrocketed.

Still, inflation has been on a steady albeit slow downward track, and sooner or later, the Fed will likely grow more confident about reaching its 2% inflation goal. The rise in energy prices and supply chain disruptions that were at the root of soaring prices have already come to an end. And with the Fed’s large-scale interest rate hikes having kept medium-to-long-term inflation expectations stable, given that a sharp rise in real interest rates (nominal interest rates minus inflation expectations) would be apt to put the economy on track for a slowdown, the inflation rate’s downward trend is not likely to be altered going forward.

Prospects for two additional rate hikes this year fading

The June CPI data produced a relatively strong reaction in U.S. financial markets. The U.S. 10-Year Treasury yield fell substantially from the 4.0% range the day before down to the 3.68% level. The dollar also weakened from 1 USD = 139 JPY to 1 USD = 138 JPY.

Yet in response to these statistics, there was no change in the market view that another rate hike of 0.25% would come at the next U.S. Federal Open Market Committee (FOMC) meeting in July. However, the financial markets have wavered from their view that the FOMC would go through with the two additional rate hikes that it had stated it would implement this year. The 30-day Federal Funds Futures market has already factored in the possibility that the July rate hike will be the final such increase. Meanwhile, there is no indication that expectations of a rate cut before year’s end have reemerged.

Chances of a market-driven YCC correction by the BOJ are somewhat lower

In response to the decline in the U.S. 10-year Treasury yield, the 10-year JGB yield in Japan has also fallen somewhat. There is now less of a risk that the 10-year JGB yield will be pulled along by the increase in U.S. long-term government bond yields to approach +0.5% (hitting the upper limit of its variability range), and that the BOJ will be forced to buy up huge amounts of government bonds to safeguard that cap.

Moreover, at this point in time, it also seems less likely that the BOJ will be driven to widen the variability range of its Yield Curve Control (YCC) again or to make other such corrections at its next Monetary Policy Meeting in July in order to avoid having to make large-scale bond purchases.

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  Takahide Kiuchi

  Executive Economist