Deflation in Japan: Another Never-ending Story

Inflation has been a hot topic lately. With commodities on the rise and rumors of rate hikes going around worldwide, many of y’all are probably already tired of reading about it! So let’s switch things up a bit and talk about something different, but equally as pressing in Japan: deflation.

Deflation is exactly what its name implies–the opposite of inflation. Basically, it’s when prices of goods and services are on the decline, and it can be gauged by a negative CPI reading. It can be caused by a decrease in money supply, an increase in the demand for money, an increase in the supply of goods and services, a decrease in the demand for goods and services, or a combination of these factors.

Now wait a second… Prices going down? What’s not to love about that?! Yes, deflation can increase your purchasing power or give you “more bang for your buck.” But in the grand scheme of things, it usually does more bad than good to the economy.

Corporate profits often take a hit when prices of goods and services fall. This negative effect eventually spills over to consumers as companies cut down on employment and wages to compensate for their shrinking profits. So in the end, while consumers may get more bang for their buck because of falling prices, they may also get less bucks to bang with!

So how deep is Japan‘s deflationary hole?

According to the core CPI report for January, prices of goods excluding food fell 0.2% compared to a year before, marking its 23rd straight month of decline.

Although CPI is still in the red, some Japanese government officials might have celebrated the most recent report with a few cups of sake. Not only did it beat the consensus which was for a 0.3% decline, but it also showed that prices fell at the slowest pace since April 2009!

Japan fell into the rut of deflation in the early 1990s and was stuck in a deflationary spiral until the early 2000s. During that time, falling prices led to lower production, then lower wages, and consequently led to further deflation.

I know some of you are already giddy at the thought of Japan finally conquering deflation with January’s CPI report. But err, I wouldn’t hold my breath for that.

I’m inclined to believe that the recent surge in commodity prices cushioned the fall of consumer prices in Japan. Digging a little deeper into the report, I also discovered that the recent drop might have been because of cheaper consumer electronics that were on post-Christmas sale and lower tuition fees thanks to government subsidies.

The good news is that the BOJ predicted that consumer prices would increase gradually over the year, thanks to the recent surge in commodity prices. The bad news is that, if wages aren’t able to keep up with rising commodity prices, it could still end up hurting growth. That’s because companies typically pass higher raw materials costs to customers, making it less affordable for them to keep spending.

Because of this, BOJ Governor Masaaki Shirakawa warned that if price levels continue to decline in the future, their economy probably wouldn’t survive without monetary stimulus. This means that the central bank would most likely keep interest rates close to zero until the evil deflationary spirits are warded off.

If you’ve been a good student in our School of Pipsology, you’d remember that low interest rates are usually bearish for a currency. Since deflationary pressures are expected to linger around for a while, the Japanese yen can’t draw support from the BOJ’s dovish policy stance.

Although Japan’s low interest rate leaves the yen as an excellent candidate for funding carry trades, another deflationary spiral could wind up dulling the yen’s safe haven shine. Do you think that’ll be the case? Vote in our poll below!