Japan's Inflation Surge: Yen's Weakness Drives Exports and Prices

Japan's inflation is expected to accelerate in November, driven by a persistently weak yen and rising energy prices. A Reuters poll of economists forecasts a 2.6% year-on-year increase in the core consumer price index (CPI), up from 2.3% in October. Exports are projected to rise 2.8% year-on-year, boosted by the yen's depreciation. But what does this mean for Japan's economy and investors?



The depreciation of the yen has a range of effects on the Japanese economy. In the case of imports, the weak yen directly translates into higher yen-based import prices. This rise in import prices raises costs for domestic firms, leading to higher consumer prices and reduced real household income, which dampens household consumption. On the other hand, changes in export prices benefit the export industry, with export volumes increasing after a certain time lag as export profitability improves and prices become more competitive, stimulating domestic production.

However, the rise in import prices also reduces the volume of imports after a certain time lag. This impact on the trade balance is known as the J-curve effect, with the trade balance initially deteriorating but eventually improving as the sales volume of exports grows due to lower local pricing. According to Olivier Jean Blanchard, former Chief Economist at the International Monetary Fund (IMF), the time lag between the exchange rate and the improved trade balance is anywhere from six months to one year.

The weak yen also influences the prices of Japan's exports and imports. The depreciation of the yen makes imports more expensive and exports relatively cheaper. In 2022, import prices rose 35% compared to the previous year, with the weak yen accounting for around a quarter of the increase. This has led to the emergence of the "bad yen depreciation theory," as the weak yen combined with rising energy prices has caused import inflation.



The rise in import prices impacts the cost structure of Japanese manufacturing companies, with higher prices for raw materials and energy, predominantly imported. This increased cost structure can lead to higher production costs, potentially impacting the competitiveness of Japanese exports and domestic prices. Industries most vulnerable to import inflation include chemicals, plastics, and metals, which are heavily reliant on imported raw materials. Additionally, energy-intensive sectors like steel, cement, and glass manufacturing face higher production costs due to increased energy prices.

In conclusion, Japan's November inflation is expected to accelerate, driven by persistently high rice prices and the phasing out of utility subsidies. The core consumer price index (CPI) is forecast to rise 2.6% year-on-year, up from 2.3% in October. Exports are projected to increase 2.8% year-on-year, boosted by the weak yen. However, this also leads to higher import prices, impacting industries reliant on imported raw materials and energy. The weak yen, combined with rising energy prices, causes import inflation, affecting the cost structure of Japanese manufacturing companies and the competitiveness of exports. As investors, it is crucial to monitor these trends and assess their impact on the Japanese economy and individual companies.