Energy Prices Drive Inflation in Japan

Energy Prices Drive Inflation in Japan

Japan’s efforts to increase inflation are getting a boost from energy prices, yet overall inflation rates continue to be below government targets of 2%.

Inflation up

Japanese consumer prices increased by 0.7% year on year in July, marking the largest break from deflation in over four and a half years. However, this increase is still under the 2.0% inflation target that the Bank of Japan has committed to achieving in two years. Prime Minister Abe and the BoJ governor, Haruhiko Kuroda, have made a bold push to end Japanese deflation by committing to doubling the monetary base and continuing asset purchases to push interest rates down.

However, excluding food and energy costs the consumer price index actually decreased by 0.1%. Energy costs as a whole rose 8.7%, which helped drive the headline inflation numbers up. This was up nearly two points from the 7% increase in June. While higher inflation numbers are taken as a positive sign of a recovering Japanese economy, Japanese households may feel some pain if the increases come solely from energy costs. Inflation tied to pricey energy imports may not push wages up in tandem, putting pressure on consumers. Abe and Kuroda would probably rather see price increases driven by aggregate consumer demand outpacing aggregate supply. This would help pull prices and wages up, leading to higher economic growth.

Haruhiko Kuroda

Haruhiko Kuroda, governor of Bank of Japan, claims a moderate economic recovery. Yet, higher inflation is largely driven by energy costs instead of aggregate consumer demand.

Japanese energy situation still affected by Fukushima

The focus on energy prices has heightened since the Fukushima disaster in 2011. Over two years after the tsunami and earthquake in Japan triggered the meltdown of several reactors at the Fukushima power plant, radioactive material continues to leak into the ground. The Japanese government recently allotted $473 million to create a wall of frozen ground surrounding the nuclear reactors to prevent seeping radioactive liquid.

This move highlights the problems Japan continues to have cleaning up the Fukushima site. Furthermore, negative news of this sort will only reinforce the anti-nuclear sentiment which resulted in widespread shutdowns of other Japanese reactors. Of the 50 Japanese reactors operating before the crisis, only two are currently supplying power. This has forced Japan to import energy sources to make up the shortfall in power production. With a falling yen due to Prime Minister Abe’s economic policies, importing energy has become more costly – a weak yen makes foreign goods expensive.

Upbeat assessment

However, following the inflation numbers and other positive indicators (industrial production was up 3.2% and unemployment dropped to 3.8% for July), Kuroda raised the BoJ’s assessment of the Japanese economic recovery, noting that it is “recovering moderately.” Continuing this momentum will feed into the debate surrounding the planned increase in the Japanese sales tax to 8% next April. This might dampen consumer purchases so it is vital that the Japanese economy continue to show strong signs of revival. High Japanese government debt necessitates that the tax increase goes forward as planned. However, if the economy weakens, Abe might be tempted to delay the measure.

Consumer sentiment could also be boosted by the recent announcement that Tokyo will be the site of 2020 Olympics. While that is far off in the future, government and private investment should ramp up as much of the Olympic apparatus needs to be constructed far in advance. Going forward, core CPI (minus energy and food) should be closely watched along with wage growth. Inflation works a lot through expectations, and if Japanese consumers believe broad based price increases are in the future, they might be prompted to make purchases and investments now. Higher wages would only boost that economic activity further.

About Author

Ned Pagliarulo

Ned Pagliarulo works for a Japanese press company, reporting on economics and government statistics. Ned received a BA in History with a minor in Japanese from Georgetown University in 2012.