Two months after Japan’s first consumption tax hike in 17 years, some data indicate the economy is stalling as prices climb and a weaker yen makes imports more expensive.
The yen’s depreciation from the Bank of Japan’s aggressive monetary easing will continue to drive up the cost of imports — especially energy and food — at a time when wages overall are falling. This means the BOJ’s inflation target is likely to trigger “bad inflation” — a toxic combination of declining demand and rising prices, analysts warn.
Prime Minister Shinzo Abe’s attempt to revive Japan’s deflation-mired economy may end in failure if the inflation the BOJ is stoking isn’t accompanied by improvement in corporate earnings and wages. If wages don’t keep up, both companies and consumers will be reluctant to spend, dampening domestic demand further, they warn.
At a May 21 news conference, BOJ Gov. Haruhiko Kuroda said that since the consumption tax rose to 8 percent from 5 percent on April 1, the economic downturn has been “within expectations” and consumption “remains on a firm footing.”
Data for April released late last month by the Ministry of Economy, Trade and Industry said that retail sales dipped 4.4 percent from a year earlier and that industrial production fell a seasonally adjusted 2.5 percent from March.
In the meantime, the diffusion index of coincident economic indicators — a key gauge of current economic activity — said the economy is sliding at its quickest pace since March 2011, when the natural and nuclear disasters ravaged Tohoku, the Cabinet Office said Friday.
Kuroda is hoping that the wage hikes demanded by Prime Minister Shinzo Abe will help offset the tax hike, but the average monthly income at salaried households in April sank 7.1 percent from a year ago in real terms, the Internal Affairs and Communications Ministry reported on May 30.
“Wages are unlikely to grow at a pace that can prop up consumer spending after the tax hike,” said Takeshi Minami, chief economist at Norinchukin Research Institute. “If income growth is tepid, retail sales will become sluggish and corporate profits will decrease, which could prompt companies to cut wages,” he said, adding, “Under this scenario, it is inevitable that the economy will languish.”
Inflationary pressures are expected to persist regardless of the state of the economy, given the effect that the BOJ’s unorthodox measures are having on the yen.
In addition to the BOJ’s quantitative easing, the U.S. Federal Reserve’s tapering of its own impressive monetary stimulus, combined with Japanese life insurers shifting to foreign bonds for higher returns, will push the yen down further, dealers say.
“As the interest rate gap between Japan and the United States is set to widen, many investors appear eager to sell the yen,” said a trader in Tokyo.
According to the Finance Ministry, the yen sank by about 20.8 percent year on year against the dollar in fiscal 2013, leaving the exchange rate at about ¥100.16 on average. As of Friday, the dollar was trading above ¥102.
With the yen falling, the core consumer price index, which excludes prices of food but not energy, surged 3.2 percent in April from a year ago — the fastest since February 1991 and up for the 11th month in a row, the internal affairs ministry said May 30.
As the BOJ estimates the tax hike will account for 1.7 points of overall inflation for April, the rise in the CPI will be 1.5 points, higher than the market expects. This excludes the effects of the tax hike.
Masanobu Ishikawa, general manager of spot foreign exchange at Tokyo Forex & Ueda Harlow, said that if the dollar tops ¥110, concerns may grow that higher import prices will trigger high cost-push inflation — a negative factor for growth. “Although many Japanese still believe that the weaker yen will shore up exports and support the economy, it may no longer benefit Japan’s economy,” Ishikawa said.
Masashi Shimominami, credit strategist at Mizuho Securities Co., said the BOJ is apparently aiming to achieve its 2 percent inflation target by spring 2015 without taking into consideration what will happen to the economy. “Bad inflation is one of the major downside risks to the economy,” Shimominami warned.
Even within the BOJ, policymakers have started to argue that the central bank must avoid any misunderstanding in financial markets about its 2 percent inflation goal and underscore that it is not pursuing higher prices without economic improvement.