Why ASX investors worried about inflation should look to Japan

For more than a decade Japan’s record high debt to GDP ratio has defied inflation.

Effect of inflation on asx shares represented by finger pointing to letter blocks spelling the word inflation

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ASX investors have been keeping a keen eye on inflation figures these past months.

And for good reason.

With the onset of the COVID-19 pandemic in early 2020, governments and central banks across the globe sprang into action to stave off an economic depression.

This saw interest rates fall to historic lows, quantitative easing (QE) ramp up to historic highs, and government stimulus packages reaching into the trillions of dollars.

These coordinated actions have been successful at limiting economic hardships from lockdowns and border closures.

However, many analysts are concerned that the flood of easy money is priming the pump for inflation to run hot.

Why is rising inflation a concern to ASX investors?

Modest annual price rises have long been baked into the economic pie.

The Reserve Bank of Australia (RBA) has an official target level of 2-3% annual inflation.

But problems arise when inflation begins to exceed these levels. To keep prices from running high too fast, central banks resort to increasing interest rates. That in turn sees your own bank bumping up its rates.

While higher interest rates can indicate a healthy economy, they also increase the cost of money.

That’s a potential concern to ASX investors, as share markets tend to thrive on low rates. When rates do go higher, other assets – like bonds and bank term deposits – become relatively more attractive to shares.

In addition, highly leveraged ASX shares will come under more pressure if their borrowing costs increase.

Now, to date, many analysts believe that the recent jump in inflation we witnessed in Australia is a temporary issue. One related to the big pullback in costs from last year.

If that’s the case, ASX shareholders can cross one worry off their lists.

Adding to that view, the latest data out of Japan appears to indicate that massive central bank bond purchases and staggering levels of government debt may not be the inflationary bugbears we feared.

Record debt to GDP ratio amid deflation

According to data from Statista, Japan’s debt to GDP ratio in 2020 stood at 256%. That’s the highest of any developed nation. A position Japan has held for more than a decade now.

Almost half of this debt is currently held by the country’s central bank. The Bank of Japan (BOJ) set the bar high with its big spending QE program in the early 2000s. And the BOJ is still going strong on bond purchases.

Yet despite all of that, as Bloomberg reports, Japan is again looking at a period of negative inflation, or deflation.

This comes as the nation restructures the weighting of items it counts in the consumer price basket. With mobile phones no longer considered a luxury but a necessity, phone charges (which have been falling) will be among the items to get an increased weighting.

Yoshiki Shinke, chief economist at Dai-Ichi Life Research Institute said, “It’s very likely inflation will fall back into negative territory.”

Economists believe June will see deflation of -0.1%, “extending the run of falls to at least 12 months”.

According to Bloomberg, “Softer prices will also likely add to the view that the Bank of Japan will keep its stimulus in place for years to come despite the inflation fears experienced elsewhere in the world.”

Of course, this doesn’t mean that Australia’s own inflation path will be equally benign.

But if it is, the ASX could benefit from an extended run of easy money.

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The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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