BOJ warns of vigilance to inflation overshoot risk as material costs rise

FILE PHOTO: A man runs past the Bank of Japan (BOJ) building in Tokyo, Japan, July 29, 2016. REUTERS/Kim Kyung-Hoon

By Leika Kihara

TOKYO (Reuters) -The Bank of Japan must be mindful of the risk that inflation may accelerate faster than expected if raw material costs continue to spike and prompt more firms to raise prices, the central bank said in a report on Wednesday.

For now, the pass-through of rising raw material costs to consumers has been focused on food products and is not spreading to a broader range of items, the BOJ said in a full version of its quarterly outlook report.

"That said, there are both upside and downside risks regarding the extent to which raw material cost increases will be passed on to the consumer price index (CPI)," the BOJ said.

The BOJ nudged its inflation forecasts on Tuesday but said it was in no rush to change its ultra-loose monetary policy, as rising prices fan speculation it may soon signal a shift in its decade-old stimulus experiment.

In a summary of the report, the BOJ projected core consumer inflation to hit 1.1% both in the year beginning in April and the following year - well below its 2% target.

Fierce competition among retailers to lure consumers with discounts could keep a lid on inflation even as the economy emerges from curbs to combat the COVID-19 pandemic, the BOJ said in the full report.

"On the contrary, there is also a possibility that raw material cost increases will be passed on to CPI more than expected," the report said.

Recent surveys have shown that companies' inflation expectations are strengthening and more firms are seeing output prices increase, the report said, adding the inflation outlook will depend on how tolerant consumers become of price hikes.

"It is necessary to take into account the possibility that prices will be pushed up by a faster-than-expected pass-through of cost increases," it said.

A separate survey showed on Wednesday the inflation rate consumers expect one year ahead was 2.16% in January, flat from a seven-year high hit in the previous month.

On the weak yen, the BOJ report said it is likely to continue having a positive overall impact on the economy, even though it hurts households by boosting prices of imported goods.

"Regardless of whether the yen depreciates or appreciates, if the exchange rates change rapidly at a pace that economic entities cannot keep up with, this may have an adverse impact on the economy," the report said.

(Reporting by Leika Kihara; Additional reporting by Kantaro Komiya; Editing by Muralikumar Anantharaman and Kim Coghill)

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