Japan’s inflation gains: Just a temporary burst of optimism?

Japan’s world-famous cherry blossoms hold deep cultural significance for its people: the beautiful pink and white flowers represent rejuvenation, as well as the ephemeral nature of life.

That description could also be used for Japan’s inflation levels: in recent months, dormant consumer prices have seen an encouraging upward revival as a result of government and monetary policies.

The trend will gladden policymakers, who have been fighting hard  over the past year to end the cycle of deflation and poor growth plaguing the Japanese economy for nearly two decades.

The big question is, will those price gains be as fleeting as the bloom of the cherry blossoms? The jury is still out on that.

For now, policy makers have reason to feel suitably sanguine about inflation. According to the latest data, consumer prices rose 1.4% in January from a year ago, gaining for eight straight months.

Core inflation — which strips  away volatile food and energy prices — was up 0.7% from a year ago.

Deflation is a phenomenon of falling prices and it has afflicted Japan for most of the past two decades, as you can see from the chart below.

japan inflation

 Note: Chart taken from CLSA’s regular ‘Greed and Fear’  investment bulletin dated February 27, 2014. The left axis of the graph measures  consumer price inflation (CPI), while the right axis (RHS) measures electricity prices.

Since late 2012, Japan has been trying an audacious economic experiment under Prime Minister Shinzo Abe.

He embarked on a three-pronged economic strategy, dubbed the ‘three arrows”, comprising a mix of suitable fiscal policies, loose monetary policies and structural reforms, to lift the economy out of its slow-growth quagmire.

So far, ‘Abenomics’ has been mainly implemented on the fiscal (economic stimulus packages coupled with tax hikes) and monetary  (easy money policies) fronts,  which seems to have, so far, helped prices to climb upwards.

The big question is, can that trajectory be maintained?

It helps to keep in mind that shaking off deflation for good isn’t an easy task and current improvements in prices have their limitations because:

One, currency depreciation has been a major driver of recently inflationary pressures in the economy.

As a Wall Street Journal report notes, the Japanese yen’s dramatic fall between 2012 and mid-2013 has led to costlier imports, the burden of which has been mostly passed on to consumers in the form of higher prices.

That’s one of the key reasons why domestic prices have been rising in Japan. A reversal in the yen’s fortunes or even medium-term stability in the value of the currency could lead to a fading of those pressures within the economy.

Two, an imminent sales tax hike in April  (from 5% to 8%) has pushed up recent consumer purchases in anticipation of higher prices in the future. How consumers behave after the price hike remains to be seen.

Three, the economy has witnessed previous episodes of prices hikes. As the chart shows, prices have gained at least twice in the past, but those gains were not sustainable. It’s entirely possible that this could simply be another ‘episode’ of non-lasting price gains.

Four, as a CNBC.com report notes, the real test of inflation taking hold in an economy, according to some economists, is when wages increase. That leads to the more-stubborn ‘demand-pull’ inflation. So far, there’s little sign of any hike in wages, the report notes.

Taken together, these reasons leave the recovery of inflation in a very fragile place. More work needs to be done by the government, in particular, in the area of structural reforms to keep prices elevated on a more firm footing. 

Otherwise, just like the brilliantly coloured cherry blossoms, Japan’s recent bump-up in inflation could be short-lived.

[Image Credit]


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