The Japanese government, which pursued reflationary policies for two decades, has just introduced a fiscal package aimed at alleviating the burden of recent - yep, _too high_ inflation. While this may sound paradoxical, it is actually not all that surprising, Commerzbank's Head of FX and Commodity Research Thu Lan Nguyen notes.

BoJ faces tightrope as inflation exceeds 3-year target

"Firstly, the tolerance of a society that has experienced nothing but deflation or minimal inflation for such an extended period is understandably low when it comes to a more prononunced rise in prices. The protest from the population during the post-pandemic inflation surge was therefore to be expected. Secondly, there has always been the question of how much leeway the Bank of Japan (BoJ) would have to curb excessively high inflation. One could argue that the central bank’s relatively moderate rate hikes have been a precautionary measure, reflecting concerns that the reflation could prove to be short-lived."

"However, with inflation having now exceeded the central bank’s target for three years, the BoJ is increasingly treading on thin ice. The risk is growing that inflation expectations could settle at a higher level, forcing the bank into prolonged restrictive monetary policy. In such a scenario, permanently higher yields might raise concerns about servicing Japan’s national debt."

"It should therefore also be in the interest of the government in Tokyo for the Bank of Japan to swiftly mitigate new inflation risks in order to prevent inflation expectations from rising. These include the inflation risks associated with the government’s newly announced stimulus measures. For this reason, the initial weakening of the Japanese yen in response to the fiscal package seemed exaggerated. After all, if the measures are implemented as announced, the likelihood of a more restrictive monetary policy will significantly increase."