Soul food now has a higher price tag, even in Japan

By Homin Lee, Macro Strategist - Asia

The famous yakitori (“chicken skewer”) shops near Shinjuku station in Tokyo are perhaps the right place to get clues about Japan’s 2018 outlook. This jostle of 60 small restaurants has been the source of culinary solace to embattled salarymen during the worst of Japan’s deflationary decades. While the charming grit and grime of the shops harkening back to the heyday of the Showa period (1945-1989) is probably a good enough draw for some patrons, we also think that the extreme stability of menu prices helped the shops’ resilience. As Japan heads into the sixth year of Abenomics, however, this pricing formula is beginning to change, creating an unfamiliar challenge for these scrappy establishments. 

The challenge mainly comes from the dearth of workers. With the Japanese labour market at its tightest in decades (see chart VII), most of these shops now rely heavily on migrant workers from developing Asian countries. Still, they are under pressure to raise prices – perhaps conspicuously already next year – not just for yakitori but also for beer, major manufacturers having just decided to adjust pricing for the first time in a decade. 

Japan’s stubbornly low prices have long been the staple of the investment community, and consumer price indices do so far support that narrative. But an expanding economy with a limited pool of young workers will eventually face price pressures, even if not along the linear relationship envisioned by the “Phillips curve ”. The good news is that the extension of Abe’s mandate reduces the risk of over-reaction to nascent inflation, since Kuroda should be re-appointed at the helm of the Bank of Japan (BoJ) or a like-minded dove replace him. Note that Etsuro Honda, a widely rumoured successor and current Japanese ambassador to Switzerland, has actually criticized Kuroda for not doing more to meet the 2% inflation target.

The key question, however, is whether the BoJ, which already owns nearly 60% of the country’s exchanged traded funds and half of its outstanding government bonds (see chart VIII), can muster enough political capital to tolerate domestic inflation above 1.0-1.5% once ordinary salarymen start feeling some squeeze in areas of usual spending, such as a relaxing dinner in Shinjuku’s Memory Lane. The squeeze will be even greater for pensioners on a fixed income (some 32% of the population already). Will Japan manage to overcome this fundamental political constraint and show other countries how deflation is beaten? We are willing to give the country some benefit of the doubt, but believe that it is still premature to make this the central thesis for 2018.