BOJ Said to See Deflation Stretching Through 2011

By Mayumi Otsuma and Masahiro Hidaka

Aug. 6 (Bloomberg) -- The Bank of Japan will probably forecast that declines in consumer prices will extend into 2011 even as the economy recovers, according to two people familiar with the matter.

The estimate would be included in policy makers’ first economic projections for the financial year ending March 2012, scheduled for release in October, said the people, who declined to be identified ahead of the report. Central bankers have already predicted prices will fall 1.3 percent in the current year and 1 percent in fiscal 2010.

Prospects for a third year of deflation make it likely Bank of Japan Governor Masaaki Shirakawa and his colleagues will keep interest rates near zero through next year, analysts said. It would also erode profits at companies such as Aeon Co., Japan’s second-largest retailer, which has been forced to offer discounts to attract consumers whose wages are tumbling.

“The Bank of Japan will hold the key rate at 0.1 percent at least through March 2011 to stop deflation from becoming deeply entrenched,” said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Securities Co. in Tokyo. “The central bank will probably consider further policy-easing action” should the risk of spiraling deflation mount, he also said.

Worst Recession

Japan is beginning to emerge from its worst postwar recession as exports improve and manufacturers boost production to replenish inventories. The revival has yet to spread to consumers, who are facing record declines in paychecks and an unemployment rate that economists say will reach an unprecedented 5.8 percent early next year.

Deflation may escalate as households, whose spending accounts for more than half of the nation’s gross domestic product, delay purchases on the expectation that goods will get cheaper, restraining a recovery in the world’s second-largest economy.

The central bank cut the key overnight rate to 0.1 percent in December, and has since begun buying corporate debt from lenders and offering them unlimited loans backed by collateral to channel funds to companies. The policy board last month extended the credit steps by three months to Dec. 31; some analysts said they’ll need to extend them again.

“With little room left to trim the key rate, the Bank of Japan will have no choice but to keep the current extraordinary policy measures, including the credit-easing programs, for a long time,” said Akio Makabe, an economics professor at Shinshu University in Matsumoto, central Japan.

Bond Yields

Subdued consumer prices have helped keep Japan’s debt yields from climbing even as the government enacted fiscal- stimulus measures. Benchmark 10-year bonds yielded 1.435 percent at 10:16 a.m. in Tokyo, down from the year’s high of 1.57 percent in June and an average of 1.47 percent the past decade.

Japan endured years of deflation earlier this decade, only defeating it in 2005. A central bank forecast signaling a return of the trend would come weeks after a new government takes office. The opposition Democratic Party of Japan leads the ruling Liberal Democratic Party in polls ahead of the Aug. 30 general election.

The central bank is bound by law to maintain price stability, and policy makers have indicated that inflation is steady within a range of zero to 2 percent. The prospect that prices will stay below that scope will force the central bank to keep the key rate unchanged at least through 2010, according to 10 of 13 economists surveyed by Bloomberg News.

Record Decline

Prices excluding fresh food, the central bank’s preferred gauge, slid a record 1.7 percent in June, in part because oil traded at about half of last year’s levels.

Central bank Deputy Governor Hirohide Yamaguchi said last month that it will take “some time” before consumer prices return to the policy board’s range. He added that there is no need for the bank to implement additional policy-easing measures for now, with the risk of a deflationary spiral being low.

Retailers are discounting products in an effort to maintain sales amid the recession. Chiba-based Aeon in July started selling house-brand beer that’s 20 percent cheaper than the equivalent products of major breweries. The company, which last month reported its fourth net loss in five quarters, cut prices on more than 6,000 items in March as rivals including Seven & I Holdings Co. and Seiyu Ltd., a Wal-Mart Stores Inc. unit, also discounted products.

Retailers Cut Prices

“Retailers are slashing prices to appeal to households, which are tightening their purse strings in response to job losses and wage cuts,” said Ryutaro Kono, chief economist at BNP Paribas in Tokyo.

Kono anticipates the Bank of Japan will in October forecast prices will fall about 1 percent in fiscal 2011 because a growing number of consumers and companies are expecting price declines.

A measure of the gap between supply and demand in Japan’s economy widened to a record in the three months ended March 31, according to the Cabinet Office.

“It’s inevitable that the Bank of Japan will forecast price declines for a third year,” given that slack in the economy has widened and growth will be subdued, said Seiji Shiraishi, chief economist at HSBC Securities Japan Ltd. in Tokyo. “The central bank will continue to focus on the economy’s downside risks.”

To contact the reporters on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net; Masahiro Hidaka in Tokyo at at mhidaka@bloomberg.net