Japan Deflation Deepens as Wholesale Prices Tumble

Japanese wholesale prices fell 6.6 percent in the year to June, the biggest annual drop on record, as the world's No.2 economy slides deeper into its second spell of deflation this decade.

Gene J. Puskar / AP A customer walks down an aisle in the Costco store in West Homestead, Pa., on Thursday, July 12, 2007. Costco Wholesale Corp. reported a 6 percent gain in same-store sales, in line with the 6.1 percent estimate. (AP Photo/Gene J. Puskar)

Declines in oil and raw materials costs weighed on wholesale prices, but falling final goods prices showed weak domestic demand was also to blame as companies curb capital spending and slash jobs following a record contraction in the first quarter.

"The slide in wholesale prices is highly likely to widen in July, August and September, exceeding 7 percent down the road. Today's data would help the Bank of Japan reinforce its cautious stance on the economy," said Tetsuro Sawano, senior fixed income strategist at Mitsubishi UFJ Securities.

Wholesale inflation has evaporated after hitting a 27-year peak last August, as the global financial crisis sent commodity prices tumbling.

The fall in the corporate goods price index was bigger than a median market forecast for a 6.4 percent drop and followed a revised 5.5 percent slide in the year to May, marking the sixth straight month of annual declines.

Reflecting weak demand at home, domestic final goods prices dropped 2.6 percent in the year to June, the biggest decline since 2002, pointing to further pressure on consumer prices, which fell a record 1.1 percent in May from a year earlier.

Wholesale prices have tended to move more sharply than consumer prices, which fell 1.1 percent in the year to May. Consumer price data for June will come out at the end of this month.

Underlining the risk of deepening deflation and weakness in final demand, the government estimates that supply capacity now exceeds actual demand by 45 trillion yen ($484 billion) a year.

The Bank of Japan and private-sector economists are forecasting at least two years of deflation.

While opinions are divided about whether this will be mild or a more serious slide that prompts consumers to curb spending, the BOJ says Japan is not facing such a deflationary spiral.

The central bank policy board meets next Monday and Tuesday.

The BOJ has cut interest rates twice to 0.1 percent in the wake of the global financial crisis last year and taken steps like buying commercial paper and corporate bonds and providing low-interest funds to banks against corporate debt as collateral.

More From CNBC.com

• S. Korea Central Bank Upgrades Economic Forecasts
• Busch: Chinese Bank Announces Bombshell
• China Think-Tank Sees 2009 Economic Growth Near 8%
• More Asia Pacific News

As credit conditions ease, debate is likely to heat up within the BOJ over whether to extend these corporate finance support steps due to expire in September, while it tries to avoid sending the wrong signal to an economy sinking deeper into deflation.

Japan's gross domestic product will grow a modest 0.4 percent in April-June, after a record 3.8 percent decline in the first quarter, according to a Reuters poll, as companies slowly build output and government stimulus trickles down.

But analysts expect any recovery in Japan to be fragile as many companies slash jobs and cut back on capital spending on weak domestic demand.

Copyright 2009 Reuters. Click for restrictions.