News Column

FOCUS: Fears growing about "bad inflation" after April tax hike

June 6, 2014

Tomoyuki Tachikawa

Two months after the country's consumption tax rate was raised for the first time in 17 years on April 1, several data have indicated Japan's economy is stalling while prices are likely to extend gains with the yen still on a weak note.

The yen's depreciation on the back of the Bank of Japan's aggressive monetary easing will continue driving up import costs, which in turn could trigger "bad inflation" -- a combination of an economic slowdown and higher prices, some analysts warn.

Prime Minister Shinzo Abe's attempt to bolster the economy may end up in failure, if inflation without an improvement in corporate performance and wage growth makes consumers and companies more reluctant to spend and dampen domestic demand further, they say.

BOJ Governor Haruhiko Kuroda said at a press conference on May 21 that the economic downturn since the 3-percentage-point tax hike to 8 percent has been "within expectations" so far, and consumption "remains on a firm footing."

But economic data for April, released late last month by the Ministry of Economy, Trade and Industry, showed Japan's retail sales plunged 4.4 percent from a year earlier and industrial production fell a seasonally adjusted 2.5 percent from the previous month.

Japan's key index of indicators designed to show the current state of the economy slid at its quickest pace since March 2011, when the devastating earthquake-tsunami disaster and the ensuing Fukushima nuclear accident significantly hurt the nation's economy, the Cabinet Office said Friday.

Kuroda has expressed hope that a possible wage increase would cushion the adverse impact of the tax change, but the average monthly income of salaried households plummeted 7.1 percent from a year earlier in real terms in April, the Ministry of Internal Affairs and Communications said May 30.

"Wages are unlikely to grow at a pace that can prop up consumer spending following the tax hike," said Takeshi Minami, chief economist at the 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 for their workers," he said, adding, "Under this circumstance, it is inevitable for the economy to languish."

Inflationary pressures, meanwhile, are expected to persist regardless of the economic situation, given that the yen has shown little sign of strengthening.

In addition to the BOJ's drastic credit easing, the U.S. Federal Reserve's tapering of its massive monetary stimulus and Japanese life insurers' boosting purchases of foreign bonds to seek higher returns will help push down the yen, dealers say.

"As the interest rate gap between Japan and the United States is set to widen, many investors appear to be eager to sell the yen," a trader at a financial institution in Tokyo said.

In fiscal 2013 through March 31, the Japanese currency dropped against the U.S. dollar by 20.8 percent on year on an average basis to 100.16 yen, the Finance Ministry said. As of Friday, the dollar stayed above 102 yen.

With the yen falling, the country's core consumer price index surged 3.2 percent in April from a year earlier, the fastest pace since February 1991, posting the 11th straight month of rise, the internal affairs ministry said May 30.

As the BOJ estimates the impact of the tax hike will account for 1.7 percentage points of the overall inflation for April, the CPI increase, excluding the effects of the tax rise, will be 1.5 points, higher than market expectations.

Masanobu Ishikawa, general manager of spot foreign exchange at Tokyo Forex & Ueda Harlow, said that if the dollar tops 110 yen, concern may intensify that import prices will bring about high cost-push inflation -- a negative factor on economic growth.

"Although many Japanese people still believe that the weaker yen will shore up exports and support the economy, it may no longer benefit the nation's economy," Ishikawa said.

Masashi Shimominami, credit strategist at Mizuho Securities Co., said the BOJ has been apparently aiming to attain its 2 percent inflation target by spring 2015 without taking into careful consideration how the economy will develop.

"Bad inflation is one of the major downside risks to the Japanese economy," Shimominami said.

Even within the BOJ, some policymakers have started to argue the central bank must avoid any misunderstanding in financial markets over its 2 percent inflation goal, underscoring the bank is not pursuing higher prices without economic improvement.

"What the price stability target aims to achieve is not a situation in which only prices will rise," Takehiro Sato, a member of the BOJ Policy Board, said at a meeting Thursday with business leaders in Oita Prefecture, southwestern Japan.

On April 30, the BOJ said in its semiannual report that Japan's consumer prices are forecast to rise around 2 percent in fiscal 2015, while downgrading its growth outlook for the domestic economy in fiscal 2014 to a 1.1 percent expansion in real terms from a 1.4 percent rise projected in January.

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Source: Japan Economic Newswire

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