Years after Japan made a cautious recovery from its long deflationary spell, the world’s third-largest economy may be headed back into a cycle of falling prices as the coronavirus threatens a deep downturn and policymakers struggle for options.
A return to deflation would be a blow to Prime Minister Shinzo Abe, who has touted an end to stagnation as a key success of his “Abenomics” stimulus policies deployed in December 2012.
Analysts say the threat is real with recent sharp falls in oil costs weighing on inflation, and the pandemic hitting an economy already on the cusp of recession.
Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute, expects core consumer prices to start falling from April and quicken the pace of declines toward year-end.
“The immediate hit to inflation will be from slumping oil costs.
But prices of other goods could also fall on weak demand as the pandemic hurts wage growth and jobs,” he said.
“It’s clear the pandemic will lead to a severe economic downturn. That’s not good for the price outlook.”
Core consumer prices will rise just 0.1% year-on-year in the second and third quarters of this year, before sliding 0.4% in the October-December period, a Reuters poll of analysts showed.
Japan’s long and troubled relationship with deflation set in after its banking crisis and recession of the 1990s.
Decades of weak demand and falling prices entrenched stubborn consumer expectations that made it impossible for businesses to raise costs and forced many into painful discounting, even during later periods of economic growth.
Those price cuts mean firms have less money to spend on wages and equipment, which in turn discourages household consumption.
Japan’s consumer prices only began to perk up in early 2013 after Abe reinvigorated the economy with radical stimulus that boosted sentiment and jobs. Annual core consumer inflation hit 0.6% in February.
But now the pandemic threatens to derail the benefits of those policies by hurting wages, cooling consumption and forcing retailers to consider job cuts. Already, prices of goods such as beef and flowers are sliding as companies are forced to cancel banquets held at the April start of Japan’s fiscal year, analysts say.
Japan’s Manufacturing Purchasing Managers’ Index also showed early signs of deflation.
Input prices contracted in March for the first time since 2016 while output charges fell the most in three-and-a-half years, as firms passed through lower raw material costs to clients.
Policymakers, who up until now had debated when to officially declare victory in the war against deflation, now privately fret over the risk of a return to sustained price falls.
“Our concern is that Japan may return to deflation. We can’t count on wage growth because the question now is how to prevent job losses,” a government official said.
“Consumer prices may start to fall. It’s not definite but there’s a risk.”
That view was echoed by a person familiar with central bank thinking, who warned of the risk of cooling business and household sentiment.
Both officials spoke on condition of anonymity as they were not authorised to speak publicly. Unlike during the global financial crisis, Japanese policymakers must combat the risks with an almost empty tool-kit.
Abe said on Wednesday the government would take necessary steps to ensure the country did not return to deflation.
But analysts doubt whether Japan can deploy a spending package as big as those launched by other major economies, without straining its already tattered finances.
A package now being worked on involves additional bond issuance of $149bn and is likely to focus on immediate support for cash-strapped firms, rather than spending to prop up demand. The Bank of Japan has already pledged to accelerate purchases of risky assets in March but has little room to expand an already massive bond-buying programme.
Deepening negative interest rates are also controversial due to the potential damage to financial institutions’ profits.
“We might see a return to deflation, particularly if the virus forces a lockdown in Tokyo,” said Ryutaro Kono, chief Japan economist at BNP Paribas.
“But the macro-economic policy tools that can be deployed are nearing the limit.”
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