The Widening Inflation Gap Between Japan and the United States Keeps a Weaker Yen -Behind service-led price volatility

 The inflation gap between Japan and the United States is widening. The year-on-year difference in consumer prices between Japan and the United States is about 6%, the highest level in 40 years. This is mainly because of the tight supply-demand balance in some goods markets. The underlying inflation gap has been a mild 1 percentage point since before the coronavirus outbreak.
 However, there is a possibility that the inflation gap between Japan and the United States could widen in the future due to service initiatives. In the United States, soaring housing prices are likely to accelerate rent hikes. Wage growth is also increasing due to a severe labor shortage, which is expected to affect service prices. In Japan, housing prices are rising and labor shortages are intensifying, but wages will only grow at a sluggish pace due to Japanese trade and employment practices.
 In general, if the inflation gap widens due to an increase in U.S. prices, the yen will weaken in the short term due to expansion in the interest rate gap (interest rate parity), and in the medium to long term, the yen is likely to rise in order to establish the law of one price (purchasing power parity). However, the service-led inflation gap may keep a weaker yen in the future due to weak adjustment pressure to the yen's appreciation. The reason for this is that there is little opportunity for price arbitrage in the service market through trade transactions and other means, making it difficult to establish purchasing power parity. In fact, unlike goods, purchasing power parity, which is measured by service prices, is not linked to the exchange rate, and the law of one price does not hold. In recent years, the imbalance in the prices of services between Japan and the United States has widened, with the price of services currently 1.7 times higher in the United States than in Japan.
 The benefits of a weak yen tend to be enjoyed mainly by overseas investors such as global companies. On the other hand, the burden of paying for imports is rising for the economy as a whole, and higher local prices are increasingly being faced by overseas travelers. It should be noted that many companies and households are facing greater disadvantages from a weaker yen than before.

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