Asia Economy

Japan faces risk of falling back into deflation, BOJ's Wakatabe warns

Key Points
  • Bank of Japan Deputy Governor Masazumi Wakatabe said on Wednesday the country could slide back into deflation if the economy comes under downward pressure again, highlighting risks such as the fallout from U.S.-China trade frictions.
  • "It's necessary to continuously examine not only the effects of our policy on inflation, but also the impact on financial markets and the banking system," Wakatabe said. 
  • The central bank is now at a crossroads because it has been pursuing radical quantitative easing for more than five years with only mixed results.
Masazumi Wakatabe deputy governor at the Bank of Japan. 
Kiyoshi Ota | Bloomberg | Getty Images

Bank of Japan Deputy Governor Masazumi Wakatabe said on Wednesday the country could slide back into deflation if the economy comes under downward pressure again, highlighting risks such as the fallout from U.S.-China trade frictions.

Wakatabe, a vocal advocate of aggressive monetary easing, said it was important to maintain the BOJ's massive stimulus program to ensure the economy remains strong enough to nudge up prices and wages.

But he noted the central bank would be vigilant to the side-effects of prolonged easing, as its huge purchases dry up bond market liquidity and near-zero interest rates hurt financial institutions' profits.

"It's necessary to continuously examine not only the effects of our policy on inflation, but also the impact on financial markets and the banking system," Wakatabe said in a speech to business leaders in Niigata, northern Japan.

"Doing so would enhance the sustainability of our policy and heighten the chance of achieving 2 percent inflation."

As an academic, Wakatabe had repeatedly called for stronger steps to drive up inflation. But he has toned down his demands for more stimulus since joining the BOJ board in March.

The central bank is now at a crossroads because it has been pursuing radical quantitative easing for more than five years with only mixed results.

Wakatabe said while Japan's economic expansion would continue, it faced various risks such as the effects of next year's scheduled tax hike to 10 percent from 8 percent and the U.S.-China trade dispute.

"Japan is only half way to achieving 2 percent inflation. If downward pressure is exerted on the economy again, it may revert to deflation," Wakatabe said.

"The BOJ will seek to accelerate inflation to levels deemed appropriate for the economy by continuing large-scale monetary easing," he said.

Under a policy dubbed yield curve control, the BOJ guides short-term interest rates at minus 0.1 percent and long-term rates around zero percent to achieve its 2 percent price goal.

Subdued inflation has forced the BOJ to maintain its huge stimulus program despite the rising costs, such as the hit to financial institutions' profits from years of near-zero rates.

The BOJ took steps in July to make its policy framework more sustainable, such as allowing bond yields to move more flexibly around its target.

The central bank's nine-member board is split between those who see room to ramp up stimulus, and those who are becoming increasingly worried about the dangers of prolonged easing.