Regular readers will have noticed (or not :)) that last month did not feature, as per usual, a note on the development of the Japanese economy. This was not the intention but since the April data came out around the same time as I had to hand in my final paper for the year time, as ever, became too scare a resource. There is not much need to worry however.
In the following I will thus continue my ongoing analysis on two months' worth of data as well as loads of timely analysis from other sources where, as usual, Ken Worsley and Takehiro Sato/Feldman from Morgan Stanley have my complete attention. In accordance with tradition four overall themes will form the backbone of the analysis; trends in prices, domestic demand figures, industrial output/exports, and finally the JPY which as ever is the subject of much attention in currency markets and beyond.
When it comes to prices it could seem as if Japan's quick return to inflation in the core-of-core index was nothing more than a blip. As can consequently be observed from the graph below Japan is once again stuck in deflation measured by the core index stripped of energy and food input; both April and May thus saw a decline in US style core prices of -0.1%.
The graph above also recounts the story of global stagflation with Japan as perspective. Thus, while core-of-core inflation remains in deflation the core general inflation index has shot up on the back of global headline inflation pressures. As will be described below this is obviously having a non-negliable effect on an already lackluster Japanese consumer. More generally, I have been emphasizing this chasm between core and headline inflation for quite some time as well as I have been pointing out that inflation in Japan was solely of a cost-push nature rather than demand-pull.
Indeed, the whole discussion of "spill-over effects" in Japan and how activity in one part of the economy (corporate capex/exports) would automatically lead to an increase in domestic demand seems now to have finally been laid to rest. This is a welcome structural break in the discourse as pundits and analysts have been waiting for these positive spill-over effects ever since the BOJ chose to end ZIRP back in 2006. So far this exercise is almost remnisient of that famous play by Samuel Beckett. A clear sign that a structural break has occurred in the analytical discourse comes from the recent writings by Morgan Stanley's Takehiro Sato and not least this specific note in which he splendidly argues the case that headline inflation pressures won't necessarily spill over into core inflation.
The idea that cost-push inflation can lead to a reflation story appears to rest on the belief that expanding corporate margins fed by price hikes can allow depressed real wage levels to recover. However, for non-durable goods we cannot expect a powerful volume boost from a consumption spurt even if prices rise, and if sales volumes are slumping corporate earnings would presumably come under pressure. The household survey data for January-March in fact show that real expenditure on items for which prices have risen (mayonnaise, canned seafood, bread, instant noodles) fell across the board.
I would be hard pressed to deliver the argument more succinctly. There are two important points here. First of all we have the point that no matter how far up those mayonnaise prices have to go it won't likely lead to front loading of expenditures. I completely agree with Sato when he argues that rising food and energy prices won't lead to hoarding (well, gas perhaps but that is hazardous). In fact, and if my readers will dare venture back to econ 101 (if possible) the cross-price elasticity of such products with respect to other goods/services will be high meaning that as headline inflation graps hold demand for these will fall. This is especially the case when real income growth is flat trending to negative.
However, cost-push inflation as a concept is not of course limited to headline inflation. This brings us to the second point. It is by now well known that input/wholesale prices are rising across the board in Japan but while these pressures are finding the consumer in the form of elevated energy and food prices it is not, to any significant degree, finding its way to consumers in the form of goods such as durables, textiles etc. This tells us an important story about the price and demand dynamics in Japan. As Robert Alan Feldman put it at some point; there is something funny about Japanese consumption. This "funny feeling", if you will forgive me my pun, has something to do with the demographics of Japan and how the capacity for mustering demand pull inflation is simply not there to any significant extent. This also finally means that inflation pressures will have a tendency to clog up in the value chain as companies find it difficult to pass on wholesale price increases to consumers, and the extent to which they do; it will have a very direct impact on consumption figures.
Speaking of which it seems that the Japanese consumer has now finally succumbed to the pressures of headline inflation rolling in over the shores of Japan. The visual inspection tells a clear story then.
The Japanese consumer put in an unexpectedly strong showing in the first months of 2008 which was also a contributing factor in presenting a more than respectable Q1 GDP figure (although exports as ever accounted for the lion's share). In April and May consumption however accelerated its decline with -2.7% and -3.2% y-o-y respectively.
