Japanese inflation is widely expected to pick up next year, a development that is seen as helping the Bank of Japan justify a faster pace of rate hikes, but some economists challenge this mainstream view. They say consumer prices will likely stay flat through the next fiscal year to March 2009, weighed down by likely sluggishness in personal consumption.
Government data on Friday showed that Japan's key inflation indicator - the core consumer price index (CPI) that excludes fresh food prices - fell 0.1 percent in June from a year earlier, marking its fifth straight month of decline.
"The latest CPI data suggested that consumers are balancing higher energy costs by cutting down their other spending such as travelling and games," said Seiji Adachi, senior economist at Deutsche Securities.
"Barring an unexpected surge in incomes, inflation will likely remain unchanged even if oil prices rise further because prices for other goods will decline," he said. A Reuters survey of 48 economists this month found that a majority see consumer prices starting to rise from the October-December quarter.
Their median forecast was for a 0.1 percent year-on-year rise in the fiscal year to March and an increase of 0.5 percent for fiscal 2008/09, both of which matched BoJ projections.
But Kiichi Murashima, an economist at Nikko Citigroup, said rises in consumer prices in fiscal 2008/09 will likely undershoot the BoJ's forecast, partly because of a lack of inflation pressures from income.
"The pace of inflation is unlikely to pick up until 2009, and thus the BoJ will find it hard to speed up the pace of rate hikes," he said. Some economists cited recent research by some US colleagues that said the Japanese method of calculating consumer prices is upwardly biased, suggesting inflation pressures may even be much weaker than government data has shown.
Christian Broda of University of Chicago and David Weinstein of Columbia University argued in a paper released this month that Japan's CPI is estimated to be overstated by around 2 percentage points.
"The paper gave some foreign investors a reason to doubt the strength of Japan's economic conditions," Adachi of Deutsche Securities said. Azusa Kato, an economist at BNP Paribas, said prices have been weak as companies are possibly caught in what she called a "zero-inflation trap."
With people's inflation expectations staying at a very low level, companies are reluctant to put higher price tags on their products, fearing they may be the only ones in the industry to do so and thus lose out to their competitors, she said.
Nevertheless, CPI will start rising eventually, Kato said, adding that the BoJ in the next fiscal year starting from March 2008 will likely raise rates at smaller intervals than the current pace of about once every six months.
"With a positive output gap, weak yen and high oil prices, all the factors related to CPI are pointing upward," she said. "It is rather puzzling that prices aren't rising." The output gap was plus 0.9 percent in the January-March quarter, marking the highest level of demand relative to supply in 15 years. The economy grew by an annualised 3.3 percent in the quarter.
The BoJ has been saying that year-on-year changes in consumer prices will likely pick up in a long run as the output gap tightens. Although consumer sentiment remains sluggish, a survey by the BoJ last week signalled that Japanese people's inflation expectations are growing after recent price hikes in some household goods such as mayonnaise.
The quarterly poll by the BoJ showed that 71.8 percent of consumers expected prices to rise over the next year, the strongest inflation expectations seen in almost a year and up from a forecast of 58.6 percent in the previous survey.
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