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Japan deflation deepens, weak demand hitting prices

Japanese core consumer prices fell a record 2.4% in August from a year earlier, as weak final demand adds to pressure from cheaper oil prices, fuelling concern that deflation may persist longer than previously thought.

While the effect of sliding oil prices will fade from September, feeble domestic consumption is increasingly weighing on prices, which could keep the central bank from raising interest rates from near zero for several years.

“Reflecting stagnant retail sales, falls in prices are spreading more broadly than we had expected... There's a chance that deflation might continue longer than expected,” said Susumu Kato, chief economist at Calyon Securities.

Core consumer prices, which exclude volatile fresh food prices but include oil costs, fell 2.4% in the year to August, matching a median market forecast and bigger than a 2.2% drop in the year to July.

The core-core consumer prices, which excludes food and energy costs, fell 0.9% in August from a year ago, unchanged from the previous month's rate of fall.

But core-core Tokyo-area prices, available a month before the nationwide data, fell a faster 1.4% in September than the 1.1% annual drop logged in August.

“Deflation is getting serious. If one retailer cuts prices, others have to do the same otherwise they cannot sell,” said Yoshimasa Maruyama, economist at Itochu Corp.

“It's true that falls in prices are not leading to a decline in consumption, as the BOJ says. But it is clearly squeezing corporate earnings,” he said.

With the economy seen slowly recovering from its deepest recession since World War Two, few economists expect falls in prices to accelerate sharply.

But weak domestic demand is likely to keep deflationary pressure alive even after the effect of the retreat of oil prices from record highs last July fades.

“Weak final demand will weigh on prices for quite a long time. Consumer prices will start rising in July-September 2011 at the earliest,” said Kyohei Morita, chief Japan economist at Barclays Capital.

The Bank of Japan has already forecast deflation to last until the year to March 2011 and is expected to extend its deflation forecast by another year in its next set of forecasts due out in late October.

That alone is unlikely to prompt the bank to take further action against fall in prices as the bank thinks a mild fall in prices does not pose a major threat to the economy.

In fact, the core-core index has kept falling even during the boom years before the global crisis.

“Perhaps the BOJ should have said more clearly that it will keep rates low for a longer period. But I think it's too late and I don't think the BOJ can strengthen its easing when globally the focus is shifting to exiting stimulus measures,” said Itochu's Maruyama.

Still, the specter of prolonged deflation is likely to keep the BOJ cautious about seeking any exit from low interest rates, unlike some other central banks in the region that are increasingly worried about inflation. (Reuters)