(Bloomberg) -- Deflation threatens to engulf Japan’s economy once again as sharply cheaper oil drains price momentum from an economy battered by the impact of the coronavirus pandemic.
Lower energy prices may push inflation below zero as early as April, according to a Bloomberg News calculation based on oil prices, published electricity pricing plans and the current exchange rate.
The return of falling prices in a rapidly contracting economy could not only buckle a cycle of weak upward momentum, it could reverse it, leaving Prime Minister Shinzo Abe and the Bank of Japan with nothing to show for their unprecedented campaign to slay deflation.
Becoming the first Group of Seven economy to slide back into falling prices would also highlight the risk to the global economy of the oil shock and virus crisis triggering a wave of downward pressure on inflation across the world.
Dangerous Disinflationary Shock Slams Reeling World Economy
With crude still far from its levels at the beginning of the year, the impact on Japan’s inflation readings is set to last for months to come as first gasoline prices fall, then electricity prices. The initial market response to an OPEC+ deal to cut oil output suggests no immediate rebound to a $50 barrel.
“Oil is a real risk,” said Nobuyasu Atago, chief economist at Okasan Securities and a former head of BOJ’s price statistics division. “Concerns over deflation are going to spread widely.”
If you adjust energy prices to take account of the drop in oil but leave all other prices the same, the main inflation gauge will fall by 0.1% in April and by 0.2% in May, with deeper drops to come in the following months as utilities factor cheaper oil into their pricing plans, according to the Bloomberg estimate.
Energy accounts for about 8% of the consumer price index basket so other price movements could still keep inflation above zero. At the same time, the calculation doesn’t account for the impact of Abe’s declared emergency in half the economy, a move that will likely drive down demand and prices for some goods and services.
BNP Paribas (PA:BNPP), Barclays (LON:BARC) and UBS all forecast inflation to turn negative this year and next.
Oil prices will remain low after the OPEC deal because of slumping global demand, but it’s not just cheaper crude that will drive down Japan inflation, according to Kazuma Maeda, an economist at Barclays Plc. Overall weakness in the economy stemming from the virus and specific items such as hotel prices and travel packages will also push down on inflation, he says.
“The outlook for Japan’s economy will ultimately depend on the virus impact but the risk of falling back into deflation is high. The economy is tanking and that is going to hit corporate profits, making them cautious about investment, spending and hiring for some time to come,” Maeda said.
Central banks around the world, spooked by Japan’s lengthy experience of deflation in the past, have worked hard to avoid getting trapped in prolonged spells of falling prices. Reining in inflation has proved easier over the years than sparking price growth once a cycle of low wage gains, low consumption and low economic growth takes hold.
Japan’s inflation stood at 0.6% in February after almost seven years of massive monetary stimulus that has seen the BOJ pile up assets beyond the size of the world’s third-largest economy.
Crude Pain
Energy helped push inflation below zero at an earlier stage of Governor Haruhiko Kuroda’s campaign to boost price growth. In June 2016 when the overall consumer price index was falling at a pace of 0.4%, cheaper energy prices dragged on the index by 1.04 percentage point.
While Kuroda initially highlighted the benefits of lower prices for consumers at that time and said buoyant spending could actually improve the price trend over the longer term, he is sticking to a more cautious tone now.
On Thursday, the governor said the economic outlook was “extremely” uncertain and refrained from mentioning the outlook for prices. Avoiding a reference to prices has come before a sharp cutting of forecasts in the past.
The central bank is due to release its latest inflation projections at its April 27-28 policy meeting.
Hideo Hayakawa, a former BOJ chief economist, said the BOJ must take the risk of deflation seriously given that it has little room left to fight against it.
The BOJ should also take a leaf out of the Federal Reserve’s playbook and skip publishing the forecasts this time because they will be too unreliable given the uncertainties over the pandemic, Hayakawa said.
What Bloomberg’s Economist Says
“Japan’s consumer price gauges are likely to turn negative by May, hit by falling oil and accommodation prices reacting to the coronavirus shock. While there could be fluctuations after that, the longer it takes the U.S. and European economies to recover and the weaker consumer confidence gets, the higher the risk that Japan’s deflation will reemerge.”
--Yuki Masujima, economist
©2020 Bloomberg L.P.