The Deflationary Pressures of Japan

Just last week I talked about the continued economic recovery in Japan and how it has benefited the stock markets and consumer spending. Japan is the second-largest economy in the world, with an estimated 2006 GDP at $4.218 trillion.

The country’s jobless rate fell to 3.7% in June from 3.8% in May, according to the country’s Ministry of Internal Affairs and Communications. The June reading was the lowest level since a 3.6% reading back in February 1998, over nine years ago. In addition, the country saw a rise in household spending in June, representing the sixth consecutive month of sequential gains.

While the economic numbers do show a positive trend, there will be pressure on the Bank of Japan to increase interest rates at the next central bank meeting on August 22-23. The country’s current interest rate is a low 0.50% and, in my view, there is a slight chance the central bank will decide to increase rates next month. The Bank of Japan has held rates in six straight meetings and does not want to derail the economic recovery.

The reality is that Japan is still facing deflationary pressures. Unless those pressures are eliminated, interest rates may hold put, as higher rates could lessen consumer demand and drive prices lower. This would hurt corporate earnings. The core consumer price index declined 0.1% in June, which was the fifth straight month of decline.

Benchmark interest rates are expected to hold during an adjustment period, waiting to see if the economy continues to develop. The central bank clearly does not want to choke off any economic momentum in the system.

Japan finally appears to be breathing better and seems set for more growth going forward. As an investor, the country has some major multinational companies that are worth a look and, versus U.S. companies, the relative valuation may be cheaper.