Japan pulls back from brink of deflation

Japan has pulled back from the brink of deflation in a day of relief for the country's central bank as core inflation rose to 0.2 per cent in March and the unemployment rate fell to 3.4 per cent.

Avoiding a slide below zero infation helps Bank of Japan efforts to instil an inflationary mindset among the populace. And while stagnant prices highlight the BoJ's continuing challenge, the lower unemployment shows its best hope - a tightening labour market that could soon put upward pressure on wages.

The consumer price index, excluding volatile fresh food prices, was up 2.2 per cent on a year ago in March. Stripping out the effect of last year's consumption tax rise, the increase was 0.2 per cent.

A preliminary reading for the Tokyo area in April came in at 0.4 per cent, suggesting the economy will escape deflation that month as well. It will remain in danger until the summer, however, when plunging oil prices start to drop out of the comparisons.

On Thursday, the Bank of Japan conceded defeat in its campaign to get inflation to 2 per cent within two years of starting a massive monetary stimulus in April 2013. It now forecasts arriving at its goal "around the first half of fiscal 2016". That could mean as late as the end of next year.

The BoJ kept monetary policy on hold but gave several hints it could consider more easing later in the year. It warned that the risks on inflation "are skewed to the downside". It also forecast inflation of just 2 per cent in the year to March 2017 assuming the path of interest rates priced into financial markets - which include the chance of further stimulus.

"It's true that the timing for achieving 2 per cent inflation has been delayed somewhat," said Haruhiko Kuroda, governor of the BoJ, at a press conference on Thursday. "But trend inflation is improving steadily and is expected to continue improving. As such, I don't think there's a need to ease policy now."

The BoJ will take heart from the strong employment data. Compared with a year ago, the labour force is the same size but employment is up by 210,000 and unemployment down by 180,000.

The BoJ's hope is that a tightening labour market will put upward pressure on wages, which will feed through to consumption and push up prices, creating a virtuous circle of prices, jobs and spending.

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