By Yasuhiko Seki

TOKYO (MNI) – Japanese retailers, airlines and even and the
government are rushing to pass along higher costs of food and energy as
bad weather and the unrest in the Middle East are adding fuel to rising
commodity markets.

Economists said while the surge in commodity prices may send
Japan’s consumer inflation into positive territory sooner than expected,
a clear end to years of deflation is hard to achieve as the gap between
supply and demand — the root cause of stubborn price drops — is
narrowing only gradually.

This means the Bank of Japan is unlikely to have reason to consider
in the near future unwinding its super-stimulative monetary policy,
which is backed by the practically zero interest rate, massive
injections of cash into interbank markets and low-interest loans to
banks that are lending to growth areas.

The Ministry of Agriculture, Forestry and Fisheries announced on
Wednesday that it will raise prices of grain for domestic flour millers
by an average of 18% to Y56,710 per ton, effective on April 1, marking
the biggest increase since 2008.

In Japan, the government, which alone has authority to import wheat
and sell it to flour millers, sets prices twice annually, in April and
October, based on its preceding half-year purchase prices.

When bad weather hit international grain prices in 2007 and 2008,
Japan’s average domestic wheat price soared as high as Y76,030 a ton in
October 2008, pushing up costs for bakeries and restaurants.

“Japan’s consumer prices will move up to the surface (out of
negative territory) before too long, possibly as early as in April,”
predicted Taro Saito, senior economist at NLI Research, a unit of
Japan’s largest life insurer Nippon Life Insurance Co.

“Given the acceleration in the pace of rises in commodity prices of
late, the core CPI may be able to log a rise of around 0.4-0.5% (year on
year) in that month,” he said.

Japan’s core consumer price index is seen falling 0.3% on year in
January vs. -0.4% in December, according to the median forecast by
analysts in a Market News International survey. That would be the
smallest drop since April 2009, when core CPI dipped 0.1%.

The Ministry of Internal Affairs and Communication will release the
CPI data at 0830 JST on Friday (2330 GMT Thursday).

The private sector is also scurrying to pass on rising production
and transportation costs to retail prices.

Coffee beans producers ranging from Ajinomoto General Foods and Key
Coffee have decided to hike delivery prices of their coffee beans while
Starbucks Japan have also raised prices of some of its coffees.

All Nippon Airways Co has applied with the Ministry of Land,
Infrastructure, Transport and Tourism, seeking approval to raise the
fuel surcharge on its international flight services, effective April 1,
following in the footsteps of its rival Japan Air Lines Co.

“If commodity prices keep rising at the current pace, Japan Inc.
won’t hesitate to hike prices in force, just like they did back in 2007
and 2008,” NLI’s Saito said.

The price tag of more than 60% of products sold at the nation’s
supermarket stores rose between October and January, according to a
recent survey by the Nikkei business daily.

Globally food and energy costs are rising in light of drought in
Russia and Northern China, flooding in Australia as well as two major
earthquakes in New Zealand since September. Growing civil unrest has
swept the Middle East, raising political uncertainties and crude oil
prices.

Tunisia ousted its president last month and Egyptian President
Hosni Mubarak resigned on Feb. 11 due to escalated anti-government
protests. Pro-democracy uprisings have spread to Yemen, Libya and
Bahrain, sending crude oil prices to $100 a barrel for the first time in
more than two years.

Bank of Japan Deputy Governor Hirohide Yamaguchi on Wednesday
warned of risks stemming from the unrest in the Middle East.

“If higher prices come from strong demand among emerging economies,
it will help increase Japanese exports, which is positive,” Yamaguchi
told a news conference in Aomori, northern Japan.

“But if they come from a political situation or a supply shock, it
won’t be positive,” he added.

Yamaguchi said he is optimistic about near-term economic growth
prospects for Japan but added that global uncertainties — the risk of
overheating growth rates in emerging economies, balance sheet
adjustments in the U.S. and Europe, sovereign risks in Europe as well as
rising costs of food, energy and metals — warrant a cautious outlook in
the longer term.

After ending in March 2006 its five-year-long policy of flooding
the money market with cash after the recovery of the banking system,
Bank of Japan policymakers sought to restore the normal functioning of
interbank dealings by raising the target for the overnight interest rate
toward 1% from zero.

The BOJ did hike its key overnight rate twice, in July 2006 and
February 2007, as Japanese exports — the main driver behind a sustained
economic growth — were boosted by a 5% global growth rate.

But after international financial markets began to show worrying
signs caused by the unwinding of the credit bubble in the U.S. and
Europe, leading the BOJ to stand pat from the summer of 2007.

In August 2007, BNP Paribas was forced to freeze its payments from
some of its hedge funds in the first sign of the subsequent burst of the
credit bubble which resulted in the failure of Lehman Brothers in
September 2008.

Around the same time, energy and commodity prices in international
markets continued to rise due to strong demand from emerging economies,
leading Japan’s core CPI to post a record 2.4% year-on-year rise in both
July and August 2008.

But soon the party was over. The global credit crisis and recession
prompted many central banks to cut interest rates and inject ample funds
into financial markets.

Japan’s core CPI reversed course, marking a record 2.4% drop in
August 2009, helped by a strong base effect resulting from the surge in
gasoline and heating oil costs a year before. But the core problem —
overcapacity against slack demand, slow corporate response to changing
lifestyles and consumer tastes — have yet to be fully addressed.

Higher consumer inflation in coming months may only push up costs
and may not support wage increases or consumption, so economists say the
latest price rises won’t change their outlook for Japan’s near-term
growth prospects or the conduct of monetary policy in the coming months.

“While rising prices of commodities have so far had only a
negligible impact on the nation’s economy, there would be a more
outright impact of crude oil prices climb above $100 a barrel again,”
said Kazuto Uchida, chief economist at Bank of Tokyo Mitsubishi UFJ.

“But if we look solely at domestic factors, the BOJ may need to
wait until around late 2013 before it can resume the normalization
process of its monetary policy,” he said.

Japan’s negative output gap — excess capacity vs. slack demand —
widened to 3.8% in the October-December quarter from a revised 3.5%
(preliminary 3.1%) in Q3, reflecting a temporary slump in economic
growth in Q4, the Cabinet Office said last week.

But the gap is expected to narrow again in the first quarter as the
economy is forecast to rebound by around 1.1% at an annualized pace,
above its potential growth rate, backed by overseas demand.

The economy shrank an annualized 1.1% in real terms in Q4, marking
the first contraction in five quarters, as it was hit by what appears to
be a temporary dip in consumer spending and slumping exports.

The output gap, which influences prices with a lag of about 12
months, has been generally improving after hitting a revised -9.2% in Q1
of 2009. Core CPI (excluding fresh food) has also been improving after
marking a record drop of -2.3% y/y in Q3 of 2009.

Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance Co.
warned of a growing risk that Japan will further lose its wealth to
resource-exporting countries as rising import prices hurt its terms of
trade.

“The current price increases won’t lure the BOJ to hike interest
rates any time soon,” Kodama said.

“What we have to worry about is a recurrence of the huge loss of
income seen in 2007 and 2008 if food and energy costs were to continue
to rise at the current pace,” he said.

Gross domestic income, which includes trading gains or losses
stemming from changes in the terms of trade, fell 0.2% in the fourth
quarter of 2010 from the previous three months following a 0.8% gain in
the July-September quarter, according to the recent data released by the
Cabinet Office.

The GDP deflator, which measures the degree of deflation, fell by
an unadjusted 1.6% in the fourth quarter from a year earlier, while the
import deflator rose 1.7%.

tokyo@marketnews.com
** Market News International Tokyo Newsroom: 81-3-5403-4835 **

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