By Yuka Hayashi
TOKYO -- The faltering global economy is prompting worries about deflation. Japan, which had to conquer the problem of widespread falling prices more than three years ago, could be the first to face it again.
Inflation in Japan, which had picked up since early this year, was caused mainly by higher oil and commodity prices, not because of strong demand in a growing economy. Now that those prices are falling sharply, inflation is easing. Economists say consumer prices may stop rising over the next several months, and may start falling sometime next summer.
Policy makers at the Bank of Japan last week cut their median forecast for the change in the core consumer-price index, which excludes fresh-food products but includes energy prices, to 0% for the fiscal year ending March 2010, compared with an increase of 1.6% projected for the current fiscal year. "Depending on conditions in the economy or international commodities markets, the rate of price increase could fall more than we expect," Bank of Japan Governor Masaaki Shirakawa said.
Merrill Lynch economist Takuji Okubo forecasts the index will fall 0.4% next fiscal year -- putting Japan firmly back in the realm of deflation.
The possible return of deflation, which dogged Japan from 1999 to 2005, adds to Japan's woes at a time when the global financial crisis is starting to hurt its economy. Deflation is a worry because it is hard to reverse, it squeezes corporate earnings and it can damp economic growth by discouraging consumers and companies from spending or investing.
It also reveals how fragile Japan's economy has been in its six years of growth before the downturn that hit this summer. Consumer demand, an important engine of growth, remained sluggish, preventing companies from raising prices enough to recoup soaring costs.
Stagnant prices, in turn, have forced the Bank of Japan to keep its interest rates super-low, leaving it little room to fight the current slump with traditional policy tools like rate cuts. The central bank last week cut its policy rate by 0.2 percentage point to 0.3%, its first rate cut in seven years.
To be sure, any price declines in Japan this time may be mild and short-lived because they are triggered by external factors that may be reversed -- lower energy and commodities prices and a higher yen that makes imports cheaper.
Economists tend to be most worried about broad-based declines in prices, in sectors outside of food and energy. For Japan, some lower prices could be a net benefit that encourages consumption by providing an effect similar to a tax cut.
In the U.S., some economists say deflation may occur if market conditions deteriorate much further and job losses proliferate. But Teizo Taya , an adviser for Daiwa Institute of Research and a former policy board member of the Bank of Japan, says it's unlikely that the U.S. will experience Japan-style deflation.
One reason: Japan faced an unusual situation, where wages remained stagnant even though companies posted higher profits because they were keeping costs low to compete with rivals in China and other nations.
That discouraged consumers from spending. Wages in the U.S. and some European nations have been rising and higher expectations of inflation are built into the economy. "One, two, three years of recession won't change that," Mr. Taya says.
Static prices have posed big challenges for Japanese companies. Sapporo Holdings /zigman2/quotes/200413497/delayed JP:2501 -6.25% Ltd., a beer maker, saw sales shrink for over a decade because of the lackluster economy and the nation's aging population. To spur demand, it launched new alcoholic drinks that were cheaper.
But that ended up cannibalizing beer sales while lowering the average price, and demand continued to shrink anyway. With beer sales now down by a third from a decade ago, Sapporo has beefed up its real-estate business and expanded overseas.
"Drinking is discretionary spending that gets cut first when the economy is bad," says Sapporo spokeswoman Tomomi Takahashi . "We don't expect an upward trend in this market from here on."
Japan's prices started rising in late 2005, but the momentum was weak. In some months, prices were still lower than the year-earlier period. Inflation began to pick up early this year, but started easing soon after energy and commodity prices began to fall in September.
Showa Shell Sekiyu KK, an oil refiner in the Royal Dutch Shell /zigman2/quotes/205095589/composite RDS.A -1.31% group started cutting wholesale prices in September and made its steepest price cut this year this month. The average pump price this week is $5.40 per gallon, 16% below its peak in August.
Signs of easing are emerging in other areas amid a slowing economy. As sales of condominiums falter and inventories begin to pile up, rent slipped 0.1% from September to September after rising moderately in recent months.
Prices of toothpaste and cosmetics have been also been sliding as retailers compete to woo consumers. The price of disposable diapers fell 5% in September, defying increases in paper and pulp prices.
"Prices of diapers have come down a lot everywhere over the past couple of decades, but they have been particularly beaten down in Japan," says a spokesman for Unicharm Corp., a Tokyo paper-products company. Unicharm is adding two to four extra diapers in a package of 30 to 66 for the year-end sale season without raising prices.
In October, the core consumer-price index for central Tokyo was flat from a month earlier, after seven consecutive months of increase. The nationwide index was flat from a month earlier in September, the latest month the data are available.
Write to Yuka Hayashi at firstname.lastname@example.org