Sept. 29 (Bloomberg) -- Japan’s consumer prices fell the most in at least 38 years in August, heightening the risk that prolonged deflation may hamper the country’s recovery from its deepest postwar recession.

Prices excluding fresh food slid 2.4 percent from a year earlier, topping July’s 2.2 percent decline, the statistics bureau said today in Tokyo. The drop, the sharpest since the survey began in 1971, matched economists’ estimates.

Companies from Fast Retailing Co. to Sony Corp. are lowering prices to attract consumers who face record unemployment and plunging wages. A return to the deflation that the economy only shook off in 2005 may weigh on growth as consumers and companies cut back spending in anticipation that prices will keep falling.

“We’ll soon start to see that there isn’t enough domestic demand to push up wages,” said Kyohei Morita, chief economist at Barclays Capital in Tokyo. “As households’ spending power falls, there’s concern that this deflation will lead to further deflation -- in other words, that we’ll enter into a deflationary spiral.”

The yen’s rally to an eight-month high also threatens to stunt the recovery by making Japanese exports more expensive and eroding the value of repatriated profits. Japan’s currency traded at 89.96 per dollar at 9:53 a.m. in Tokyo from 89.63 before today’s report and rose as high as 88.24 yesterday, the strongest since January.

Record Unemployment

A report this week will show the jobless rate reached 5.8 percent last month, topping July’s postwar record, according to a Bloomberg News survey of economists. Wages probably slid for a 15th month in August, figures are expected to show tomorrow.

Bank of Japan Governor Masaaki Shirakawa said this month prices will continue to fall for “some time.” Central bank policy makers, who lowered the overnight lending rate to 0.1 percent in December, said they remain concerned about the strength of the economy even as it shows “signs of recovery.”

Tokyo core consumer prices slumped 2.1 percent in September from a year earlier, also a record, the bureau said. Figures for the Japanese capital are released a month earlier than nationwide data, making them a harbinger of price trends.

Much of the drop in prices reflects last year’s peak in oil costs. Crude reached an unprecedented $147.27 a barrel last July, and has dropped more than 50 percent since then.

‘Persistent Deflation’

The oil effect “will diminish over the next few months, quite quickly,” said Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo. Even so, Jerram expects prices will keep falling for at least another three years as the country enters a period of “persistent deflation.”

Even when excluding food and energy, consumer prices fell 0.9 percent in August, the same pace as July, which was the sharpest decline in seven years, the bureau said.

Fast Retailing, owner of the clothing chain Uniqlo, said this month that a third of its g.u. brand’s fall-winter items will be priced at 990 yen ($11).

Sony slashed the price of its PlayStation Portable player in Japan by 15 percent to 16,800 yen, only three months after reducing its PlayStation 3 prices. Such moves, while spurring demand, may also eat into the company’s profits, which fell 53 percent last quarter from a year earlier.

To maintain profit margins while lowering prices, some retailers have introduced their own product brands. More than two-thirds of consumers said they intend to buy more private- label products, according to a Nikkei News survey.

“Companies are placing more emphasis on selling higher volumes of their products. That way, factories can maintain their operating levels and retain their workers,” Barclays’ Morita said. “Pricing strategies are becoming an increasingly important for many sectors of the economy.”

To contact the reporters on this story: Aki Ito in Tokyo at aito16@bloomberg.net; Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

Last Updated: September 28, 2009 21:02 EDT