Japan's deflation curse takes a pause as giant stimulus package bites

Output figures lift hopes and nation gets back on the road to recovery

Japan's 20-year battle against deflation could be at an end as the world's third-biggest economy saw rising prices for the second month in a row.

The latest figures showed prices rising at an annual rate of 0.7 per cent in July, accelerating from 0.2 per cent in June, as the Bank of Japan attempts to hit a 2 per cent inflation target with a huge monetary policy stimulus and shake off decades of economic malaise.

Although some economists noted that the price rises are due in part to higher electricity bills and the weak yen, which has pushed up import costs, politicans hailed the data. "Japan is escaping from deflation," the economics minister, Akira Amari told journalists yesterday.

Industrial output added to the cheer as it jumped 3.2 per cent on the previous month, in a further sign the recovery, set back by 2011's catastrophic earthquake and tsunami, is finally taking hold. Officials predict further expansion in August and September.

Société Générale's economist Takuji Aida said: "Japanese industrial production and labour market figures suggested a firm recovery and consumer prices added to evidence that deflation is finished, certainly for now."

The BoJ launched "shock and awe" tactics in April with plans to nearly double its monetary base to ¥270 trillion (£1.7trn) by the end of 2014, buying ¥7.5trn of bonds per month to weaken the yen and boost exports.

The plans form part of the "three arrows" of economic reform under Japan's Prime Minister Shinzo Abe, along with public investment and structural changes such as encouraging immigration and trade.

But yesterday's clutch of economic data also showed average household spending fell 1.4 per cent in July from a year earlier, despite slight improvements in income and the jobless rate, which fell to 3.8 per cent from 3.9 per cent the month before. Retail sales also fell year on year for the first time in three months.

A government survey of Japanese firms' capital expenditure between April and June due on Monday will carry more weight than usual because of its potential to influence a political debate over the tax rise.

If Monday's survey leads to a downward revision to second-quarter GDP, which was already below expectations, it could be used by those opposed to the current plan to raise the sales tax to 8 per cent next April and then 10 per cent in October 2015.

The fragile nature of the recovery increases pressure on Mr Abe, who must decide within the next month whether to go ahead with a planned rise in VAT next year to bolster the public finances.

Under a multi-party agreement reached last year, the government must confirm the economy is strong enough to withstand the impact of the tax hike before implementing it.

The hike is seen as an unpopular but important first step in dealing with public debt, which has topped ¥1,000trn and at double the size of GDP is the worst among leading countries.

Initial estimates showed the Japanese economy grew an annualised 2.6 per cent in the second quarter, well below expectations for 3.6 per cent growth.

Capital expenditure in the GDP report was down 0.1 per cent, a sixth quarterly fall in a row.

Revised GDP figures are due later this month and the government has indicated that the results will be a factor in its decision on the sales tax increase, which is now expected by early October.

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