articles Ratings /ratings/en/research/articles/220907-economic-research-why-japan-s-consumer-inflation-will-drop-back-below-2-12493313 content esgSubNav
In This List
COMMENTS

Economic Research: Why Japan's Consumer Inflation Will Drop Back Below 2%

COMMENTS

Economic Research: Economic Outlook Eurozone Q3 2022: Crunch Time

COMMENTS

Economic Research: Economic Outlook Asia-Pacific Q4 2022: Dealing With Higher Rates

COMMENTS

Economic Research: Emerging Markets Real-Time Data: Mixed Picture Amid Higher Prices And Tighter Financial Conditions

COMMENTS

Economic Research: The Underbelly Of Germany’s Export Prowess


Economic Research: Why Japan's Consumer Inflation Will Drop Back Below 2%

Japan is bucking the trend. While "cost push" pressures are raising headline consumer inflation globally, the recent (modest) increases in the country's consumer prices are likely temporary. Powerful structural factors contain this dynamic in the country. S&P Global Ratings expects consumer inflation to fall below the Bank of Japan's 2% target again in 2023, making a shift away from its highly accommodative monetary policy unlikely any time soon.

The hefty rises in consumer price index (CPI) inflation in the U.S., Europe, and elsewhere have prompted talk that Japan's consumer inflation might finally start to rise significantly. This is important because a substantial, sustained increase in CPI inflation would lead the Bank of Japan (BOJ) to change its long-running highly accommodative monetary policy. More convergence between Japan's monetary policy and that in the U.S. and Europe is likely to meaningfully bolster the yen.

Structural Forces Keep CPI Inflation Low

Cost-push pressures raised consumer inflation in Japan to 2.6% in July. But this is low compared with the elevated levels in the U.S. and Europe (see chart 1).

Japan's consumer inflation has been low for a long time, for good reason. Prices have remained suppressed because of the country's long history of muted growth in consumer demand, the low inflation expectations that this has created, and the prioritization of employment stability over wage growth.

Japan's personal consumption has been falling more than GDP in recent years. Hit heavily by the pandemic, real personal consumption fell on average by 1.5% per year between 2018 and 2021, compared with an average annual real decline of 1.1% in GDP. Amid such weak demand conditions, consumer-facing firms haven't felt confident raising prices. As a comparison, in the U.S., real personal consumption grew 2% on average in this period, while real GDP rose 1.4%.

Personal consumption has been weak over a longer period. This is in part because of a long-term decline in the share of labor income to GDP. In the 20 years to 2021, Japan's personal consumption grew on average 0.3% per year in real terms, less than the 0.5% average real GDP growth in this period (see chart 2). Thus, the expansion of consumption has been small even compared with the modest growth of overall economic activity and production. In the U.S., average annual real private consumption growth in this period of 2.2% exceeded real GDP growth.

Chart 1

image

Chart 2

image

The low CPI inflation in Japan in recent decades in these circumstances has led to low inflation expectations. Headline CPI inflation averaged 0.2% in the 20 years through July 2022, and "core core" inflation (excluding energy and food) 0.0%. In the U.S., headline CPI inflation averaged 2.4% in the same period and core inflation averaged 2.1%. This led to what the BOJ governor Haruhiko Kuroda has called the "zero inflation norm," [1] with companies reluctant to pass on cost increases for fear of losing market share.

This is especially true in the services sector, but "everyone… [is] acting essentially in concert to keep prices unchanged," said Mr. Kuroda in a speech. Notably, for example, internationally operating Japanese companies tend to use profits from overseas to subsidize domestic operations, allowing them to absorb cost increases rather than passing them on.

The Norms That Keep Consumer Inflation At Bay

Forceful legal and cultural norms discourage firms from implementing price increases that could result in lost market share. Labor laws and convention make it very difficult for companies to cut their regular labor force. Many employers and employees are focused on employment stability rather than wage increases. Firms keep employees in weak times; the flip side of that coin is that they pay relatively moderate wage increases in good times.

Persistently low wage growth has also weighed on CPI inflation. Wages--to be more precise, unit labor costs, the amount of wage costs per unit of product--are a key determinant of prices. Wage growth in Japan has been low for a long time, especially in the service sector.

Changes in the composition of the labor force have affected wage statistics, particularly the steep rise in the share of part-time and temporary workers.

Looking at the average wage per hour avoids most misinterpretation. On this metric, wages fell by an average of 0.2% per year between 2000 and 2015. They rose by an average of 2% per year between 2015 and 2020, in part because some large, profitable companies heeded government calls for higher wages. But most smaller companies, especially in services, have not been profitable enough to lift wages.

In any case, a recent reduction in the number of hours worked in recent years has helped to limit the impact of some increase in wages on unit labor costs. This reduction was mostly due to the replacement of retiring regular employees with part-time workers, or those on temporary contracts.

Sustained Rise In Core Inflation Unlikely

The sharp increases in global energy and commodity prices since 2021, combined with large yen depreciation, have sharply increased costs for many companies. A significant number of companies have raised prices for consumers, including for food products. This is testing the "zero inflation norm." Indeed, it is likely that more companies will raise consumer prices in the coming six months, including internationally operating firms that will see lower profits from overseas operations. This could in principle set in motion a process toward higher underlying inflation.

However, in our view the current price increases are largely cost-push pressures. A sustained increase in core inflation remains unlikely, especially given the headwinds to economic growth. In June, we forecast that CPI inflation would average 2.2% in 2022, and 1.4% in 2023.

The prevalence of subsidies and import restrictions also constrains consumer price increases. This dampens the effect of changes in global prices on prices faced by Japanese consumers. In the energy area, measures including price controls on electricity tariffs and gasoline and rail transport subsidies weaken the link with global prices.

As a result, in June, Japanese consumers faced 16.2% year-on-year increases in energy prices, compared with a 33.0% spike in the U.S. Import restrictions, which elevate the domestic prices of products, including rice and other grains, also suppress the effect of higher global food prices. Japanese retail food prices were 4.4% higher than a year ago, compared with 10.9% in the U.S.

While Japan CPI is brushing above the key 2% threshold, we find it more notable how low price-increases have been in the country amid generationally high inflation globally. Japan remains an outlier on this front. The economic structures that suppress consumer price rises in the country remain sturdy, and will continue as such.

End Note

1. The Bank's Thinking on Monetary Policy: Toward Achieving the Price Stability Target in a Sustainable and Stable Manner, Speech at the Kisaragikai Meeting in Tokyo, June 6, 2022

Editor: Jasper Moiseiwitsch

Related Research

This report does not constitute a rating action.

Asia-Pacific Chief Economist:Louis Kuijs, Hong Kong +852 9319 7500;
louis.kuijs@spglobal.com
Secondary Contact:Takamasa Yamaoka, Tokyo + 81 3 4550 8719;
takamasa.yamaoka@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.


Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back