Japan’s Deflation Deepens as Prices Fall Record 2.2%

By Mayumi Otsuma

Aug. 28 (Bloomberg) -- Japan’s consumer prices fell at a record pace in July, adding to signs that deflation will hamper a rebound from the nation’s worst postwar recession.

Consumer prices excluding fresh food declined 2.2 percent from a year earlier after dropping 1.7 percent in the previous month, the statistics bureau said today in Tokyo. It was the sharpest decrease since the survey began in 1971.

Japan is once again facing deflation, a sustained bout of falling prices that plagued the economy for a decade until 2005. Stemming the declines and sustaining a recovery will be a challenge for the winner of this weekend’s general election.

“Nothing can stop prices from falling now, given that demand has deteriorated so much,” said Masaaki Kanno, a former central bank official and now chief economist at JPMorgan Chase & Co. in Tokyo. “Consumer-price declines threaten to squeeze corporate profits because material costs are edging up” and companies are unable to pass them onto customers, he said.

Consumers, whose spending accounts for more than half of the economy, may delay purchases if they expect goods to get cheaper. That would erode profits and force companies to keep cutting wages, which tumbled an unprecedented 7 percent in June.

Even when excluding food and energy, consumer prices fell 0.9 percent in July, the fastest pace in seven years, the statistics bureau said. Core prices in Tokyo, a harbinger of nationwide price trends, fell 1.9 percent in August.

‘Long-Term Battle’

Atsushi Mizuno, a Bank of Japan policy maker, said last week that price declines will “ease only at a moderate pace” through the year ending March 2012. Central bankers have already predicted prices will slide 1.3 percent in the current fiscal year and 1 percent in the following 12 months.

The bank should “be prepared to fight a long-term battle” with deflation because it has cut the key interest rate to 0.1 percent and has few tools to prop up inflation and economic growth in the short-term, Mizuno said.

“The pace of core price declines may be approaching a peak because the effect of last year’s oil-price gains will start to fade soon,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. “But it’ll still take time before prices stop dropping.”

Crude oil has lost half of its value since peaking at $147.27 a barrel in July 2008. It has rebounded in recent months, climbing 61 percent since the start of this year on expectations that demand for energy will pick up as a global recovery takes hold.

Price Expectations

Central bank Governor Masaaki Shirakawa said this month that price declines will moderate in the second half of this fiscal year, though he added the bank will monitor the risk that inflationary expectations may wane.

“We’ll start to see if there’s real deflation once the August CPI comes out,” because that figure will be less skewed by last year’s oil surge, said Junko Nishioka, an economist at RBS Securities Japan Ltd. in Tokyo.

The result of the Aug. 30 lower-house election may also affect Japan’s inflation, some economists say. The opposition Democratic Party of Japan, which opinion polls show will likely take power, has promised to abolish some taxes on gasoline and auto purchases next year and make highway tolls free.

The tax exemptions would cut core prices by 0.53 percentage point and the highway toll removal would shave off 0.34 percentage point, according to an estimate by Ryutaro Kono, chief economist at BNP Paribas in Tokyo.

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