Deflation Grabs Hold of Japan
Like I noted in the small snippet I posted on Facebook on this (hint: add me), I really don't want to beat a dead horse here and although I already gave it a kick in the context of the release of the May consumer price data I do think that this is pretty significant [quote from Bloomberg with my emphasis].
Japan’s producer prices fell at a record pace in June as oil costs declined and companies required fewer materials amid a global recession. The costs companies pay for commodities and unfinished goods tumbled 6.6 percent from a year earlier after sliding a revised 5.5 percent in May, the Bank of Japan said today in Tokyo. The median estimate of 22 economists surveyed by Bloomberg News was for a 6.4 percent drop.
Today’s report may stoke concern that deflation will take hold and hamper a rebound from the nation’s worst postwar recession. Bank of Japan Governor Masaaki Shirakawa said this week that his policy board will watch out for the risk that the economy and prices will slip below its forecasts.
“Viewing the broader price trend in the domestic economy, we would have to stress that homemade deflationary pressures are strengthening,” said Kyohei Morita, chief economist at Barclays Capital in Tokyo.
As I pointed out in the context of the consumer price release and as a general rule of thumb we can expect all y-o-y inflation figures coming in over the summer to be biased downwards due to the low base effect from very high headline inflation during the summer of 2008. Yet, I also showed that with respect to the consumer price data it was not entirely a question of headline disinflation since also the core-of-core index slid substantially on an annual basis. This analysis is backed up by a closer look at the data from Ken Worsley which clearly indicates that when it comes to policy makers and analysts, "on the ground" as well as of course the message from the raw data, Japan's domestic economy is providing a clear deflationary bias at the current juncture.
Today's release of the corporate goods price index for June can probably be given the same analytical treatment in the sense that although the disinflationary bias from lower headline inflation will be there there appears to be a strong underlying gravitional pull from the deflationary pressure from the lack of domestic demand. One interesting point here is in particular the tepid change in discourse away from the stubborn anticipation of the feedback from higher energy prices to core inflation and thus, in relation to producer prices, that companies would push on higher input prices on to consumers. Clearly, this scenario did not materialize and one has to wonder whether counting on it to happen might not constitute a parallel to that famous play by Samuel Beckett.
Rather, it is noteworthy to see that many analysts and policy makers are now beginning to focus on the fact that the squeeze in prices is also a result of the fact that there are no pull inflation but rather the opposite; Kyohei Morita being one example here. Apart from being deflationary in and of itself it also means that whatever the amount of input inflation it is likely to be clogged up in the value chain eroding the profit margins of those companies who rely on domestic demand to sell their products. It is interesting in this regard to point out that if we look at the evolution in the monthly figure (3 period moving average), the trend is still distinctly deflationary and in this specific case petroleum and coal products actually contributed positively but was weighed down by other goods and commodities. The monthly figure has been negative on a three month moving average basis since January 2009. In the context of the annual figure the low base effect is substantial with petroleum and coal products decline 41%, but it is important to point out that the decline in corporate goods prices is broad based which indicates that the only thing we need to consider in terms of the low base effect is the level of the decline and not the sign. Finally, it is worth pointing out that in terms of export and import prices the decline in bigger in the former than in the latter on an annual basis which suggest that Japanese exporters might be scoring some points on this account (and here I am not accounting for the currency effect which may tip the load in any direction).
In conclusion, deflationary pressures are intensifying in Japan and it is important for a whole host of reasons. Most prominently, there is an expectational element here and one which may be particularly sinister in Japan. In fact, and if we have learned anything from this crisis it is that managing expectations and especially avoiding lingering expectations of deflation is a key policy parameter. In this sense it is worrying to see that the BOJ's effort, albeit valiant, may be falling short.