By Leika Kihara
TOKYO, May 27 (Reuters) – Bank of Japan Governor Kazuo Ueda said on Wednesday central banks should not look at oil prices in isolation because a temporary energy shock can become persistent if it feeds into wages, expectations, and price-setting behavior.
Comparing various energy shocks Japan experienced in past decades, Ueda said the same oil price increase can have very different effects on wages, expectations, demand and currency rates depending on the initial conditions at which they hit.
“If inflation expectations are already high and wages are accelerating, the risk of second-round effects is large,” while a large cost shock may not raise inflation expectations if expectations are very low and wages are stagnant, he said.
“Thus, the boundary between temporary and persistent inflation is not mechanical,” Ueda told a conference hosted by the BOJ and its think tank, the Institute for Monetary and Economic Studies.
The remarks come as surging oil prices from the Middle East conflict add to inflationary pressure in Japan’s economy, prompting BOJ officials to dial up hawkish signals that have led markets to expect an interest rate hike as soon as next month.
“A temporary shock can become persistent if it changes wages, expectations, and price-setting behavior. Conversely, a large shock can remain temporary if those channels do not activate,” Ueda said.
‘FIFTH OIL SHOCK’
Japan’s core inflation as measured by a new central bank gauge accelerated in April and blew past its 2% target, data showed on Tuesday, helping make the case for an interest rate hike as soon as next month.
Ueda described the oil spike caused by the U.S.-Israeli war on Iran as a “fifth oil price shock” and said policymakers can learn from their experiences in dealing with previous shocks.
The first oil shock in 1973 hit Japan when inflation was already close to 10%, leading to growth in wages and prices nearly 20% a year later, Ueda said.
While the BOJ did tighten monetary policy, the move came after high inflation had already become embedded and the degree of monetary tightening was inadequate, he added.
When Japan faced a second oil shock around 1979 and 1980, inflation remained far more moderate not just because the BOJ tightened monetary policy promptly, but because it came when inflation was lower and wage behaviour was more restrained, he said.
Exchange-rate moves also made a difference with the yen appreciating substantially during the second oil shock, helping to reduce import prices, Ueda said.
Unlike the third oil spike in the late 2000s, the supply shock caused by the Ukraine war led to broader-based price rises with inflationary pressure amplified by a weak yen, he said.
The episode changed how Japanese firms and households saw price moves in the future, making them more willing to raise prices and demand higher pay, Ueda said.
“Japan’s experience shows that oil price shocks are never just oil price shocks,” he said. “They are tests of the entire inflation regime.”
(Reporting by Leika Kihara; Editing by Christian Schmollinger, Shri Navaratnam and Thomas Derpinghaus)
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