The latest piece of news of Japan does not make for happy reading I am afraid and although we have seen some tentative signs, as of late, of a stabilisation this has to be very preoccupying for Japanese policy makers. As Edward pointed out recently, the rise in consumer confidence and sentiment in general is masked by a strange absense of any kind of material pick up in real economic indicators and now we get the follow blow to the kidneys.

Japan’s consumer prices fell at a record pace in May, adding to the risk that deflation will become entrenched and hamper a rebound from the nation’s worst postwar recession. Prices excluding fresh food slid 1.1 percent from a year earlier after dropping 0.1 percent in the preceding two months, the statistics bureau said today in Tokyo. It was the sharpest decrease since comparable figures were first compiled in 1971.

Bank of Japan Governor Masaaki Shirakawa said last week that price declines will accelerate through the middle of the fiscal year as demand slackens and crude oil continues to trade lower than last year’s record. Retailers including Aeon Co. are cutting prices to attract customers as falling wages and the worsening job outlook damp spending. “Profits fall, then wages come down, then consumers stop shopping,” said Junko Nishioka, chief Japan economist at RBS Securities Japan Ltd. in Tokyo. “And because people aren’t shopping, companies lower prices. That’s the process that we’re starting to see. It isn’t easy to break out of.”

Now, you might think that this sharp decline has fuel/energy prices written all over it. In some sense this is true. In May, fuel prices registered its first annual drop in several months (-3.0% yoy) which clearly adds to the headline grapping number. Yet, the decline in prices in Japan is broadbased and although the -1.1% is clearly pushed down by a high base effect as we enter a period in which 2008 energy prices were comparatively large, the core of core index slid -0.5% which marks a change of -0.4% from the previous month. In short; the recession in Japan is beginning to push the economy into the dark hole it has spent nearly two decades trying to escape (and never really managed). The point here is not to harp about headline inflation and whether it will go up or down since we are clearly going to be in situation over the next couple of months in which headline deflation on an annual basis will skew the overall index downwards. But this is hardly the point since, as we can see, the core or core index is declining fast too which tells us that domestic demand pressures in Japan are clearly negative at this point in time and may remain so for as far as the eye of a trained economist should be willing to see.

Japan may be sinking into deflation that will undermine the nation’s rebound from its worst postwar recession, the Cabinet Office’s chief economist said. Deflation “will exert a significant amount of downward pressure on the recovery,” Jun Saito, an adviser to Economic and Fiscal Policy Minister Kaoru Yosano, said in an interview yesterday in Tokyo. “An increase in deflationary expectations will raise real interest rates and that will restrain business investment.”

Consumer prices excluding fresh food dropped a record 1.1 percent in May from a year earlier, the statistics bureau said today, spurring concern that the economy is slipping back into the deflation that plagued the nation for a decade until 2005. “Declining prices will mean lower profits, less investment and wage cuts that will weaken consumer spending further,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co.

So, where do we go from here you might ask. Well, this is exactly the issue; there isn’t a whole Japan can do at this point but to try to position itself in the best possible ways for exploiting the global green shoots through exports. However, when it comes to the domestic economy deflation is an inbuilt part of the edifice.

Last 5 posts by Claus Vistesen

• Random Shots - November 13th, 2009
• The IMF on Asia's Recovery and its Sustainability - November 9th, 2009
• Too Much of a Good Thing in Australia? - November 5th, 2009
• Japanes Companies, Exports and the Current Account - November 2nd, 2009
• Are Americans Becoming Less Nomadic? - October 25th, 2009