Is inflation expected for Japan?
CPI has been rising but fell in February
Consumer price index (excluding fresh food) year-on-year rate of change in Japan reached 4.2 percent in January 2023. The rate has been positive since September 2021 and has been rising consistently (Figure 1). Even in Japan, where deflation has been the norm, fear of inflation is gradually intensifying.
On the other hand, CPI rate of change has fallen to 3.1 percent in February 2023. The preliminary estimate for Tokyo, which showed a fall from 3.4 percent in February to 3.3 percent in March, indicates that the rate may fall further for the nation as a whole in March 2023.
Should we expect inflation to sustain in Japan, or is the current signs of inflation only a temporary phenomenon?
Breakdown of CPI shows different trends
What needs to be noted in this respect is the fact that, while the year-on-year rate of change is still positive, CPI index itself has fallen in February 2023, first fall in index since December 2021 (Figure 1). Whether this is a temporary fall or a sign of a more long-term fall is of interest.
In order to see the reasons for the fall, Figure 2 shows the breakdown of CPI (excluding fresh food) to indices showing the price changes in (a) food (excluding fresh food), (b) energy, and (c) CPI (excluding food and energy). It shows that, while energy prices have fallen by 10.7 percent in February from January, prices of food (excluding fresh food) have risen in February by 0.7 percent from the previous month as well as CPI (excluding food and energy), which rose by 0.3 percent between January and February.
Import prices of energy have fallen
First is on the fall in energy prices. There are two factors that explains the recent fall of energy prices.
One is the fall in import prices of crude oil and natural gas. As Figure 3 shows, import prices of petroleum, coal and natural gas in yen basis has been on a declining trend since October 2022. It is a result of a declining trend of these goods in contract currency basis, which had started to fall in October 2022, and the appreciation of the yen that has taken place since November 2022.
If we can expect the imported energy prices to fall further because of the less tight commodity market situation and the stability of the value of yen, the pressure on CPI from import prices of energy should continue to alleviate in the future.
The other factor is the impact of the policies that have been implemented to reduce the burden of rising energy prices by subsidizing oil, electricity, and city-gas companies. Policy to suppress gasoline prices has been implemented since January 2022, and is currently planned to stay until the end of September 2023. Policy to contain electricity and city-gas prices has started from use of these energy sources in January 2023 which is billed in February 2023. It is expected to be implemented until the usage in September which will be billed in October 2023.
When the energy price stabilization measures terminate, energy prices should be adjusted to match the market determined prices. In addition, 7 out of the 10 electricity companies have already submitted their proposals to Ministry of Economy, Trade and Industry (METI) to raise their utility rates, initially from April or June this year (it is still under scrutiny by the government so that their approval should be delayed). Therefore, a one-time adjustment in energy prices to take place sometime in the future is inevitable. However, whether the energy prices are to keep on rising depends on the future development in the commodity market and the exchange rate.
Import prices of food and agricultural products have also fallen
Second is on the steady rise of food prices. Food also depends greatly on imports, not only on imports of food that directly affect food prices, but also on imports of forage crops for domestic livestock which have indirect impact on food prices. In that respect, it is a relief to see that import prices of beverages and foods and agricultural products for food in contract currency basis have peaked in August 2022 and, together with the appreciation of the yen, their import prices in yen basis have also started to fall in November 2022 (Figure 3).
Different from electricity and city-gas rates, where there is an arrangement for the electricity and city-gas companies to be able to automatically pass-on the increase in oil and/or natural gas prices to their retail prices, it takes some time for the food companies to raise their retail prices to cover their cost. Therefore, food prices are expected to rise for some time yet. As a matter of fact, there have been a significant number of foods which raised their prices this April. However, since the import prices of foods and agricultural products have started to fall, it is difficult to expect that food prices will continue to rise.
Wages to rise at an unprecedented rate
Finally, it is on the rise in prices of goods and services other than food and energy, i.e., CPI (excluding food and energy). As we have seen in Figure 3, this item is still increasing gradually, and its year-on-year rate of increase has reached 2.1 percent in February 2023. If it is going to sustain, the long-awaited achievement of the 2 percent inflation target could be in sight. The trend of these items depends on the future of wages.
This year’s Shuntou (spring wage round) is still in progress. However, the outcome so far (in mid-April), mainly reflecting the decisions made in larger companies, is for the pay-raise to be close to 4 percent (Figure 4). If the final outcome is going to follow this trend, this year’s wage increase could be the highest since early 1990s.
However, it should be noted that the pay-raise announced as the outcome of Shuntou by the companies and the labor unions includes the increase in wages due to an additional year of seniority: it does not necessarily mean an increase in the average wage of workers in macro sense. As Figure 4 shows, increase in the scheduled cash earnings per full-time employees is significantly lower than the announced pay-raise in Shuntou. From that point of view, excluding the wage increase reflecting additional seniority, and focusing on the “base up” (upward revision of pay schedule of the companies) is better indicator of increase in the average wage of workers.
For example, the outcome of 2023 Shuntou so far (in mid-April) is said to be a pay raise of 3.75 percent compared to previous year. However, if we exclude wage increase due to an additional year of seniority and focus on the base-up, the pay-raise will fall to 2.11 percent. Nevertheless, it is significantly higher than the base-ups we have seen in the recent years of only around 0.5 percent.
Wage increase of this magnitude is necessary for the workers in the current situation if the workers are to maintain the real purchasing power of their wagess: according to the ESP forecast published this April, consensus forecast is for the CPI (excluding fresh food) in FY2023 to rise by 2.15 percent. However, the concern is that a wage increase of this magnitude will exert an upward pressure on unit labor cost and could be a factor raising CPI. Wouldn’t it lead to a home-made inflation?
Such a wage increase, which we have not seen in the recent years, does not necessarily mean that inflation (sustained increase in aggregate prices) is on the way.
First, if the increase in wage increase is a special phenomenon that is seen only in this year, CPI will only see a one-time upward revision of prices. It is only when we see a wage increase of this magnitude in the future as well that we may face a sustained rise in prices.
Second, even if we are going to see a wage increase of this magnitude in the future as well, if labor productivity is high enough, the cost will be absorbed and unit labor cost may not have to rise. If labor productivity is high enough, we may even say that such a wage increase is necessary in order to offset the deflationary pressure that was with the Japanese economy for a long time.
Whether the Japanese economy is going to face an inflation or not depends on how wage increase and labor productivity will develop in the future.
Coping with uncertainty to overcome deflation and to avoid inflation
On the basis of the discussion made above, we may say that Japan is at a crossroad in terms of price developments.
On the one hand, import inflation seems to be receding: commodity prices have started to fall and exchange rate has stopped weakening. How will the commodity prices behave in an unstable global economy? Will the exchange rate of yen remain stable or will it appreciate/depreciate?
On the other hand, wage is increasing at a rate that has not been seen in the recent years. Will wages keep on rising at this pace in the future as well? How will the labor productivity be?
It cannot be denied that there is a great uncertainty in all of this. It is important for the government and the central bank, therefore, to carefully monitor and analyze the future developments, and to take appropriate measures to overcome the chronic deflation that has been with the Japanese economy but, at the same time, to avoid future inflation.