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CPI is down but Shirakawa opposes more rate cuts. Will he hold the line?

October Japanese consumer inflation came in lower for the second month in a row yesterday, reaching 1.9% year-over-year as lower commodity prices eased pricing pressure. Other circumstances could have provided an opportunity for a rate cut but, with the overnight call rate already at 0.3%, BOJ governor Shirakawa has publicly pledged to abstain from further cuts, favoring other strategies to increase liquidity. He can’t cut from zero – how strong a stance these Japanese economic ones are!

This policy course may become more politically difficult for the BOJ with mounting evidence that the recession is deepening rapidly. Data released this week registered a month-over-month decline of 3.1% in industrial production in October and rapidly slowing export data in recent months suggest still further production cuts ahead. Meanwhile domestic demand is slowing rapidly with household spending down 3.8% in October –the eighth consecutive monthly decline, and retail sales for October that were lower by 3.3% year-over-year.

Unemployment dropped to 3.7%, the lowest level since July 2007 and the second lowest since 1998. While at face value this data looks surprisingly positive, all is not as it seems. Japanese employment data does not acknowledge the division between permanent employees and temporary workers, the so called “haken”, who work outside the pension and benefits social-safety-net (see our September 7th post). Toyota’s recent factory layoffs, for instance, were confined to temporary workers, who will not be fully factored into official unemployment data. The figure also excludes those who have ceased looking for a job –a rising group among less educated young adults in large cities.

With the memory of the “lost decade” fresh in the minds of policy makers, the reluctance to take rates to zero again makes simple sense. One alternative measure to spur growth was a corporate tax break on repatriating offshore income proposed by the tax commission. Ideas like this seem to be superior to cutting rates further but, with rates already at a mere 30 basis points, the damage may already be baked in Japanese Stagnation cake.

We are short the Japanese equity market via the EWJ ETF and the yen via the FXY ETN. We sincerely hope that Japan does not suffer the same prolonged stagnation that it experienced in the 90’s, but if you read our work you know that we do not consider hope a valid investment thesis. We will remain short as long as the data tells us to.

Andrew Barber