Japan Poised for Era of Sustainable Inflation, Nomura Say

Japan is poised to exit more than a decade of deflation as a strengthening yuan bolsters China’s buying power, fueling Japanese production and buoying prices, according to Nomura Holdings Inc. (8604)

Demand from China will propel continuous gains in Japanese consumer prices next year as companies ramp up production with factories now running at about three quarters of capacity, Takahide Kiuchi, Nomura’s chief economist, said in an interview on April 13. The yuan has gained 5.2 percent against the yen this year, making Japanese products more affordable in China, which became Japan’s biggest overseas market in 2009.

Premier Wen Jiabao last month said China will adopt policies to encourage domestic consumption and wean the country from its dependence on exports. The shift may help Japan absorb a glut of unused factory capacity and unwind a cycle of declining prices that has weighed on economic growth. Deflation has driven wages down 16 percent since a 1997 peak and caused tax revenues to fall by about 20 percent in the same period, according to government data compiled by Bloomberg.

“Even mild deflation is a bad thing,” Kiuchi said. “When people expect deflation, wages tend to decline more rapidly. That means real wages decline and that undermines consumption.”

Photographer: Kiyoshi Ota/Bloomberg

Pedestrians and shoppers walk past commercial buildings in the Ginza district of Tokyo. Consumer prices excluding fresh food unexpectedly rose 0.1 percent in February from a year earlier, the first gain in five months, the statistics bureau said on March 30. Close

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Photographer: Kiyoshi Ota/Bloomberg

Pedestrians and shoppers walk past commercial buildings in the Ginza district of Tokyo. Consumer prices excluding fresh food unexpectedly rose 0.1 percent in February from a year earlier, the first gain in five months, the statistics bureau said on March 30.

Japanese companies are using about 73 percent of their factory capacity, according to trade ministry data released yesterday. An increase in capacity utilization to about 85 percent in August 2007 preceded Japan’s last period of inflation, a 15-month stretch of price gains between October 2007 and December 2008.

Idle Factories

Prices resumed falling in March 2009 during the depths of the recession that followed the bankruptcy of Lehman Brothers Holdings Inc. when plunging exports forced Japanese companies to idle as much as half of their factories.

China’s share of Japan’s exports more than doubled in the decade through 2011 to about 20 percent, finance ministry data shows.

Consumer prices excluding fresh food unexpectedly rose 0.1 percent in February from a year earlier, the first gain in five months, the statistics bureau said on March 30. Nomura, SMBC Nikko Securities Inc. and NLI Research Institute Ltd. expect the Bank of Japan to expand its asset-buying when the board gathers on April 27 to help meet an inflation goal of 1 percent.

No ‘Magic Wand’

Governor Masaaki Shirakawa, who last week began attending ministerial meetings on Japan’s persistent price declines, has said that lack of demand is the “root cause of deflation” and the central bank has no “magic wand.” The Bank of Japan has held its key interest rate near zero for most of the period since 2001, raising the rate no higher than 0.5 percent.

Japan’s core consumer prices have fallen in 42 of the 56 quarters since 1998, according to data compiled by Bloomberg. The average pay for Japanese workers fell to 3.8 million yen ($47,250) last year from 4.5 million yen in 1997, labor ministry reports show. Without adjusting for price changes, household spending fell 8.4 percent in the 10 years through 2011.

Deflation and Japan’s low-interest rates have also weighed on the stock market. The Nikkei 225 Stock Average (NKY) has fallen about 50 percent since July 1998, when consumer prices started to slide. The Standard & Poor’s 500 Index gained about 40 percent in the same period.

Money Into Stocks

“Inflation causes interest rates to rise and that pushes money out of bonds into stocks,” said Masakuni Fujiwara, chief executive officer at VistaMax Fund Advisor in Tokyo. “Price gains caused by a narrowing of the supply-demand gap will also be positive for companies.”

While outlays by Japanese consumers has fallen, wages for Chinese workers are increasing and the yuan’s gains are increasing the mainland’s purchasing power.

Even after its appreciation this year, the yuan still has room to rise against the yen, Nomura’s Kiuchi said. China’s currency is 7.8 percent weaker than its one-year peak of 11.847 yen set in October. Goldman Sachs Group Inc. predicts the yuan will increase 3 percent against the dollar by the end of 2012.

A strengthening yuan will also relieve deflationary pressure by making Chinese imports more expensive, reducing competition for Japanese manufacturers of home appliances, clothes and other products, Kiuchi said. China on April 14 doubled the yuan’s trading band to 1 percent, giving officials more flexibility to adjust monetary policy.

“The yuan’s strength will weaken the competitiveness of China’s exports,” Kiuchi said. “That will also help Japan escape deflation.”

Other contributors to Japanese inflation include oil prices, higher tariffs by Japan’s biggest utility, and a pick-up in household spending ahead of proposed sales tax increases in 2014 and 2015, Kiuchi said.

Kiuchi isn’t the only one predicted price increases in Japan. Investors’ expectations for inflation in Japan are rising at the fastest pace among Group of Seven nations, except Canada, as indicated by interest-rates for inflation-linked bonds.

To contact the reporters on this story: Sam Waite in Tokyo at swaite1@bloomberg.net; Masaaki Iwamoto in Tokyo at miwamoto4@bloomberg.net

To contact the editors responsible for this story: Nick Gentle at ngentle2@bloomberg.net; Grant Clark at gclark@bloomberg.net

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