Japan's inflationary pressure likely stalled

Despite the BoJ's commitment to the 2% price stability target, inflationary pressure has stalled due to the downtrend in oil prices and sluggish demand after the consumption tax (CT) hike. The CPI (ex fresh food) finally fell below 0% yoy in August. 

Firm economic sentiment, supported by Abenomics, has been a driving force behind Japan's progress toward exiting deflation. However, the real economy (including exports, production and GDP growth) and inflation have been much weaker than economic sentiment. 

"If this continues, the government and the BoJ's strong commitment to the 2% inflation target will be open to question. If the market and corporates are disappointed, economic sentiment will deteriorate and there will be no driving force to ensure an exit from deflation. This could be a big risk to the Japanese economy", opines Societe Generale. 

The government and the BoJ's policies must support economic sentiment until the real economy and inflation strengthen. Consumer sentiment has remained weak due to the CT hike in April 2014, and a further CT hike will be implemented in April 2017. In addition, there is rising uncertainty surrounding external factors such as China. 

A complete exit from deflation is very close, but the road ahead is rocky. One last additional economic stimulus package would not cost that much politically or financially. However, if the government and the BoJ neglects to go ahead with this, there is a big risk that Japan would ultimately fail to escape from deflation, just as was the case in the past. 

Both the government and the BoJ need to realise that a similar mistake cannot occur again. Against this backdrop, it is essential for the government and the BoJ tocontinue to support economic sentiment through policy until the real economy and inflation strengthen. 

"It is likely that the government will try to declare a complete exit from deflation by the time the upper house election is held next summer. PM Abe's ruling coalition will likely target voters by pointing to the success of Abenomics. For this to materialise, the government and the BoJ are expected to re-accelerate its monetary and fiscal policies as soon as possible", added Societe Generale. 

To have an actual feeling that Japan is exiting deflation, it is important that the equity market rallies. In addition, PM Abe's support ratio needs to recover as Abeused his political capital for the enactment of national security legislation in September. In this context, the government is likely to support the BoJ in implementing additional QQE measures.