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Japan logs record deflation as demand slides

Japanese core consumer prices fell a record 1.7% in the year to June, with weakening consumer demand for goods playing an increasing part in pushing the country deeper into its second spell of deflation this decade.

It was the fourth straight month of decline, matching a median market forecast and accelerating from a 1.1% drop in May in another sign the world's second-largest economy is stuck in the doldrums with rising job losses and falling wages hurting household spending.

The Bank of Japan is forecasting two years of deflation, so price falls alone are unlikely to push it back into full-blown quantitative easing, which in Japan involved flooding the banking system with cash to meet a specific monetary target.

But the central bank's view -- that price falls won't accelerate once the effect of last year's energy price spike fades -- may be questioned as it becomes increasingly clear that final demand is playing a larger part in overall price falls.

Roughly 70% of the drop in the core consumer price index (CPI), which excludes food prices but includes energy costs, was due to falling energy prices, data showed on Friday.

But the so-called core-core CPI, which cuts out the sliding energy bill, fell 0.7% from a year earlier and the decline has gathered steam for four straight months, suggesting deflation may persist unless household demand picks up.

“If you look at the core-core CPI, the pace of declines has accelerated, suggesting price competition has been putting downward pressure on prices. Consumers are becoming more conscious of cheaper products,” said Yasuhiro Onakado, chief economist at Daiwa SB Investments.

It was the biggest fall since December 2004 in this index, which is similar to underlying inflation indicators used in Europe and North America.

Prices fell for goods ranging from flat-screen television sets and cellphone bills to overseas package tours.

Of the range of items that make up core CPI, 47% saw price falls in June from a year earlier, up from 39% in May. It was also the first time in three years that the number of goods whose prices fell exceeded the number logging price gains, adding to evidence that deflation was broadening.

“Firms including those in the retail sector are competing to get demand through offering cheaper prices, and that could put pressure on their profits,” Onakado said.

Japanese government bond futures were down on the day, focusing on gains in the stock market as the data was in line with market expectations.

Core consumer prices for Tokyo, available a month before the nationwide data, also fell a record 1.7% in July from a year earlier.

Analysts expect annual consumer price falls to exceed 2% in the coming few months before narrowing to around 1% by year-end, a view also widely held within the BOJ.

Many BOJ officials believe no further policy action is needed unless Japan risks slipping into a deflationary spiral, in which falling prices and a weak economy feed into each other.

The central bank believes the risk of this happening is small because the economy will likely pick up later this year with support from reviving global demand.

But some economists disagree.

“The economy is picking up so it is unlikely that Japan will fall into a deflationary spiral, but such a risk could emerge if the economy's recovery stalls and the US economy falters,” said Yoshiki Shinke, senior economist at Dai-ichi Life Research Institute.

Having just emerged from almost a decade of deflation after the collapse of a property bubble in the 1990s, Japan's economy has been sideswiped by the global financial crisis that started in 2007 with a US mortgage market meltdown.

While the economy is expected to have bounced back in April-June after five straight quarters of contraction, analysts say any recovery will be fragile as companies slash jobs and cut capital spending, weakening domestic demand.

The unemployment rate hit a six-year high and job availability sank to a record low, suggesting consumers are unlikely to loosen their purse strings any time soon. (Reuters)