How Distant Is Japan's 2% Inflation Target?

Tokyo, Japan
Tony Bonaventure | Photographer's Choice | Getty Images
Tokyo, Japan

Japan's consumer prices fell for the fourth consecutive month in February highlighting how challenging it could be for the central bank to achieve its 2 percent inflation target, which analysts say is unlikely at least over the next two years.

Looking at the data released on Friday, Junko Nishioka, chief Japan economist at RBS, said it was unrealistic to believe the government could achieve 2 percent inflation in the next couple of years.

"As long as the Japanese economy continues to recover, I expect CPI [consumer price index] number to recover from the current level, but it may take at least four years to meet the target of 2 percent," Nishioka said.

Japan's core consumer prices, which exclude fresh food but include energy, fell 0.3 percent in February from a year earlier - a fourth straight month of declines - but the drop was slightly slower than a market forecast of a 0.4 percent fall.

(Read more: Japan Factory Dip Surprises, Prices Keep Grinding Down )

The world's third biggest economy, however, has been battling deflation for nearly two decades amid poor growth and a strong currency.

But expectations of a turnaround in consumer prices have been rising with the new governor of the Bank of Japan (BOJ) Haruhiko Kuroda vowing to use all means available to achieve a target of 2 percent inflation in two years. This has led to wide speculation that the central bank would expand stimulus measures at its next policy-setting meeting on April 3-4 to try to spur price growth.

(Read More: BOJ's New Head Vows to Use All Means to Hit Price Target )

But analysts say consumer prices will continue their downward trend at least until the second half of this year.

"Deflationary pressure is remaining for the time being, but after that from the second half of this year, the inflation number is likely to recover on the back of the recovery of the economy," Nishioka said.

Masayuki Kichikawa, chief Japan economist, Merrill Lynch Japan Securities, adds that the impact of any monetary easing by the BOJ on consumer prices probably won't materialize until the end of 2013.

"It takes about nine months to one year before monetary policy change begins to have impact," Kichikawa said. "First of all, we need to see what happens by the first half of next year -if we achieve some slight inflation 0.1-0.3 percent that would a first good step and if we could continue that trend, there's some possibility in late 2015 we could approach at least some level above 1 percent.

Yen Needs to Stay Low

The yen, meanwhile, can no longer appreciate if the BOJ plans to take a serious stab at getting rid of deflation, according to Kichikawa.

"The yen needs to be stabilized at least at current levels," Kichikawa said. "If we keep the level of the yen in the 95-100 range that will begin to have some impact on the CPI early next year."

Since November when Japan's new Prime Minister Shinzo Abe started talking about the need to revive the economy and advocated a more aggressive monetary policy, the yen has fallen about 17 percent against the U.S. dollar.

While a weaker yen will increase import prices and can push up consumer prices across the board, RBS' Nishioka said it's unclear how long the government can prevent the yen from strengthening.

"It [weakening the yen] may cause some political pressure from other countries," Nishioka said.

Japan has already faced criticism for meddling in currency markets, sparking fears of a currency war.

(Read more: Yen Meddling - What has Japan Started )

-By's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu