Japan’s Economy Gains Momentum in Struggle to Escape DeflationBy
BOJ output gap latest sign of progress in deflation fight
Broad measure of economy hits highest level since 2008
Japan’s economy is running the hottest relative to capacity since the global financial crisis. More than four years after the Bank of Japan launched its radical monetary easing, key conditions are aligning in its long battle to truly escape from deflation.
The latest reading of the nation’s output gap, released on Wednesday, is another milestone on the journey to that escape, economists say.
“The positive output gap shows Japan is making progress toward becoming a normal economy," said Hiroshi Miyazaki, senior economist at Mitsubishi UFJ Morgan Stanley in Tokyo. "We are now in a similar situation as before the Lehman shock in 2008, when Japan enjoyed a prolonged recovery thanks to a global economic expansion."
The BOJ’s output gap, a measure of the balance between supply and demand in the whole economy, rose for a third straight quarter during the first three months of this year, reaching the highest level since 2008, the central bank said on Wednesday. That means demand now clearly exceeds supply in an economy undergoing its longest expansion since before the crisis.
Yet Japan is among countries around the world that are seeing inflation lag behind economic growth. Core consumer prices are rising only slowly--by 0.4 percent in May--and remain well below BOJ Governor Haruhiko Kuroda’s 2 percent target, prompting expectations that the BOJ will lower its inflation forecast when it releases its quarterly outlook at this month’s policy meeting.
Still, the tightest labor market in decades is expected to get even tighter, helping drive long-awaited wage gains. And Japanese consumers, hammered by a sales-tax increase in 2014, are showing signs of returning to health.
“The continuing positive output gap is a step toward ending deflation and the BOJ must be gaining confidence because of it," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute.
While Prime Minister Shinzo Abe has said Japan is no longer in deflation, he hasn’t declared the end of deflation. The Cabinet Office defines the latter as reaching the point where there is no risk of returning to deflation, or continuous price declines, and measures it according to four criteria: the output gap, consumer prices, the GDP deflator, and unit labor costs.
Recent poor price readings stem mainly from temporary factors, while the stable recovery in domestic demand and the growing labor shortage are expected to change company pricing behavior, with core inflation reaching 1 percent in the next 12 months, UBS analysts, led by economist Daiju Aoki, said in a research report last week.
"We think Japan can and will overcome deflation," they said.
The positive output gap shouldn’t be taken as a sign of a sharp acceleration in inflation, said Hiroshi Ugai, chief economist at JPMorgan Chase & Co. Japan’s low potential growth rate, which is under 1 percent, makes it easier to achieve a positive output gap, while companies remain unconvinced about the nation’s growth prospects in the longer term, he said.
“I expect the output gap to stay in positive territory while creating inflationary pressure only little by little,” Ugai said. “That’s because companies are very concerned about higher business costs so they don’t want to raise wages without having confidence in the outlook for the economy.”
The Cabinet Office’s own estimate of the output gap, released last month, was positive for the first quarter and will likely widen ahead, with inflation eventually accelerating, Takeshi Yamaguchi, chief economist at Morgan Stanley MUFG Securities, said in a research note last month.
"We see a risk that the government may declare an exit from deflation by the end of this fiscal year, before the end of BOJ Governor Kuroda’s term in April next year," he said.