Japan's Inflation Probably Exceeded 2% for First Time in Decade

By Mayumi Otsuma

Aug. 27 (Bloomberg) -- Japan's consumer-price inflation probably exceeded 2 percent for the first time in a decade as companies passed rising costs onto households, deterring spending and weakening the economy.

Core prices, which exclude fresh food, climbed 2.3 percent in July from a year earlier after rising 1.9 percent in June, according to the median estimate of 37 economists surveyed by Bloomberg ahead of government figures to be released Aug. 29.

Price increases are unlikely to prompt the Bank of Japan to raise interest rates anytime soon because the economy is on the brink of a recession and Governor Masaaki Shirakawa expects inflation will ease. Factory output and household spending fell in July and the jobless rate stayed close to a two-year high, analysts predict separate reports will show on the same day.

``Consumer prices will probably begin to decelerate in the fourth quarter but continue to damp consumption at least until early next year,'' said Yoshiki Shinke, a senior economist at Dai-Ichi Life Research Institute in Tokyo. ``The next rate increase will be in the third quarter of 2009 at the earliest, and only after the bank confirms a pickup in the economy.''

Only one of the economists predicted July inflation at lower than 2 percent. Core prices haven't risen 2 percent since January 1998, when they were boosted by a sales tax increase. Excluding the tax, they last gained that much 16 years ago.

Shirakawa said this week that core price gains will moderate after accelerating ``slightly'' in coming months. There are few signs commodity-driven inflation is spreading because wage growth is weak, he said. Crude oil has fallen 21 percent since exceeding $147 a barrel for the first time on July 11.

`Key Factor'

Excluding food and energy, prices rose 0.1 percent in July from a year earlier, economists predict, the same pace as June and only the third gain since 1998. Faster increases in the gauge would be the ``key factor'' in determining interest-rate action by the central bank, said Takuji Okubo, a senior economist at Merrill Lynch & Co. in Tokyo.

The Bank of Japan has kept the key overnight lending rate at 0.5 percent since doubling it in February 2007. It shelved a policy of gradual rate increases in April.

Demand for goods and services slipped below Japan's productive capacity for the first time in almost two years last quarter, a Cabinet Office report on the output gap showed this week, adding to signs that inflation remains subdued. The central bank last week described the world's second-largest economy as ``sluggish'' for the first time in a decade, after a report showed gross domestic product fell an annualized 2.4 percent in the second quarter.

Reaching Peak

``As oil-driven inflation eases, the pace of consumer-price gains will also slow, while the economy's weakening demand will make it difficult for companies to raise prices,'' said Akira Maekawa, an economist at UBS AG in Tokyo. ``Core prices will probably peak at around 2.5 percent in the current quarter.''

Bank of Japan policy makers consider core prices to be stable between zero and 2 percent. Breaching the range ``will only be temporary and probably won't induce any policy action,'' said Ryutaro Kono, chief economist at BNP Paribas in Tokyo.

Core prices in Tokyo, a harbinger of nationwide inflation, advanced 1.7 percent in August from a year earlier, according to the median estimate of 34 economists. Prices in the capital increased 1.6 percent in July.

Kokuyo Co., an Osaka-based stationery maker, this week said it will raise prices of photocopy paper by 9 percent in October to reflect higher costs of oil and wood chips. Tokyo Electric Power Co. plans to adopt a new pricing system next month to better respond to changes in fuel expenses.

Carmakers, which had managed to absorb cost increases by increasing productivity, are also attempting to charge more.

Pricier Prius

Toyota Motor Corp., Japan's largest automaker, said this week that it will raise prices on some domestic models for the first time in 16 years, paving the way for smaller rivals to follow suit. Still, Toyota plans to limit price increases to popular hybrids, such as the Prius, and some commercial vehicles.

``It's still doubtful that retail price increases of cars and other durable goods will spread at a time when consumption is so weak,'' said Shinke of Dai-Ichi Life. ``It's still hard to expect the Japanese economy to head into overall inflation.''

Household sentiment fell to the lowest level in at least 26 years in July, and consumers' willingness to buy long-lasting products also slid to a record low.

Weakening demand at home and abroad prompted companies to cut production 0.4 percent in July from a month earlier, a second consecutive decline, economists estimate. Household spending dropped for a fifth month and the unemployment rate stayed at 4.1 percent, according to analysts surveyed.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net