The central bank failed to sound a deflation alert.
“At present there is no reason to expect that overall prices will drop sharply and exert deflationary pressure on the entire economy,” policy makers wrote in their monthly report, signed off by the governor.
That governor was Yasuo Matsushita and the report was published in January 1998. Within six months, Japan’s consumer prices excluding food began falling in a trend that would mark the next 15 years.
The concern now for economists from Barclays Plc to Morgan Stanley and JPMorgan Chase & Co. is that European Central Bank President Mario Draghi risks making the same mistake as the Bank of Japan ― publicly playing down a deflation threat ― and ultimately may have to introduce quantitative easing.
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Mario Draghi, president of the European Central Bank. (Bloomberg) |
Among a series of similarities between 1990s Japan and modern-day Europe: Weak economic expansion after a series of shocks? Tick. A reluctance by banks to lend? Tick. A rising exchange rate? Tick. A debatable monetary-policy stance? Tick.
“The risk of a Japanification of the euro area is high and rising,” said Joachim Fels, chief international economist at Morgan Stanley in London, who puts the odds of a price decline at about 35 percent. “Deflation wasn’t on Japan’s radar either.”
The Bank of Japan’s complacency hurt an economy that has slipped in size behind China’s as companies and consumers retrenched in anticipation of even cheaper prices. The country’s gross domestic product, unadjusted for changes in price, was 10 percent smaller last year than its 1997 peak. The Nikkei 225 Stock Average, at 14,898 Wednesday, is less than half its 1989 high, and public debt tops 200 percent of GDP.
The malaise prompted BOJ Gov. Haruhiko Kuroda to pledge last year he would boost the monetary base to lift inflation to 2 percent. Consumer prices excluding food climbed 1.3 percent in January.
“Until too late, the Bank of Japan didn’t think Japan was going to be entangled with deflation,” said Kenji Yumoto, vice chairman of the Japan Research Institute Ltd. and an economic adviser to the government in the late 1990s. “The ECB still can’t be complacent. Europe is lucky to have Japan’s case study.”
A broad-based drop in prices across the 18-nation euro area would push investors into government bonds and away from the euro as the ECB began asset purchases, according to analysts at Societe Generale SA, who see a 15 percent probability of such an outcome.
While Morgan Stanley analysts say equity investors are discounting the likelihood of deflation, a relapse in growth could encourage them to buy stocks they consider resilient because of low debt or links to countries outside of Europe. These include Adidas AG, LVMH Moet Hennessy Louis Vuitton SA and Deutsche Telekom AG. Potential losers from deflation include Commerzbank AG, Air France-KLM Group and BNP Paribas SA.
Just the fact that deflation is in debate leaves Draghi under pressure as the ECB’s Governing Council prepares to meet tomorrow in Frankfurt. A month since he signaled a willingness to tackle low inflation, about a quarter of forecasters in a Bloomberg News survey say he and colleagues will reduce their benchmark interest rate from a record-low 0.25 percent. Other options are cutting the so-called deposit rate, lending cheap cash to banks and ceasing to mop up the liquidity created by crisis-era bond purchases. (Bloomberg)
“I do not think that, at the moment, the risk of materialization of the deflationary threat” is there, former ECB President Jean-Claude Trichet told reporters in Abu Dhabi Wednesday. “That being said, the low level of present inflation is something the ECB has to look at and could justify further decisions.”
Draghi maintains the euro area isn’t turning Japanese, even as he accepts that soft inflation will linger and the International Monetary Fund warns his economy may be prone to deflation if it’s hit by a shock. Medium-term inflation expectations among economists and in the financial markets remain “firmly anchored” around the ECB’s goal of just below 2 percent, and the region is strengthening, he told reporters Feb. 6 in Frankfurt.
Price pressures in the wake of Europe’s debt turmoil are similar to those following past periods of economic stress and not much worse than in the U.S., Draghi said. The weaknesses that do exist are less pervasive than in 1990s Japan and are mainly in nations, such as Greece, that must rein in prices and wages to restore competitiveness, he added.
Since he spoke, data have shown inflation exceeding forecasts, climbing 0.8 percent in February. Economic confidence also rose unexpectedly, and a report Wednesday showed an acceleration in services growth.
“We don’t see much of a similarity with what happened in Japan,” Draghi said. “There’s certainly going to be a subdued inflation ― a low inflation ― for an extended, protracted period of time, but no deflation.”
Erik Nielsen, chief global economist at UniCredit SpA in London, shares that view. He says there’s “a very low” chance the eurozone “goes into a deflation that becomes nasty.” Falling prices for energy and other goods may even help the economy by lifting spending power, he added.
“Behind closed doors” ECB officials nevertheless may be more worried than they appear in public and are concerned that voicing those worries would mean deflation becomes “self-fulfilling,” said James Ashley, chief European economist at RBC Capital Markets in London.
(Bloomberg)
