Japan Flirting With Deflation Again

The health of China's manufacturing sector and the renewed risk of falling prices in Japan will dominate Asian market attention.

Japanese inflation could sink to its lowest reading since June 2013 and not far above where it stood when Prime Minister Shinzo Abe won his first election on December 16, 2012. It's two and a half years later now and there is scant evidence to suggest that the era of exceptionally low rates of inflation with multiple episodes of deflation has ended. 

In fact, it's entirely conceivable that this will just be a third failed attempt to buck long-run deflationary forces since the property and equity market bubbles popped . What had driven a temporary rise in inflation following Abe's re-election was a rise in import prices due to yen depreciation that had occurred in response to the Bank of Japan's easing policies, higher electricity prices in response to closing nuclear generating facilities, and a sales tax hike. 

With Bank of Japan Governor Haruhiko Kuroda recently remarking that the yen was "unlikely to weaken further in real effective terms", markets took it as a cue not to expect further BoJ stimulus soon which would not help headline inflation through yen effects on import prices. 

No further BoJ-induced yen weakness may, however, stop hurting core inflation since higher import and electricity prices crowded out other types of spending in the context of weak wage gains and tight access to credit. There is the opportunity to further clarify the Bank of Japan's position when the minutes to the May 22nd Bank of Japan meeting are released on June 23. In light of Kuroda's comments, the risk is that the minutes will be stale.