Japan's core consumer prices fell for the first time in four months in the year to October after a cigarette tax hike a year ago dropped out from calculations revealing persistent deflation caused by chronically weak domestic demand.
In fact, November data for the Tokyo area showed deeper declines that exceeded analysts' forecasts and backed the view that the Bank of Japan will maintain ultra-easy monetary policy for the foreseeable future.
A narrower measure of prices that excludes both food and energy fell from a year ago in a sign that the world's third-largest economy continued to struggle with lackluster job market, weak consumer demand and excess capacity.
Core consumer prices fell 0.1 percent as forecast in a sign of weak aggregate demand as a strong yen and spillover from Europe's sovereign debt crisis dampen export demand.
Bank of Japan Governor Masaaki Shirakawa on Friday expressed the central bank's growing alarm that the euro zone crisis may bring more pain for the Japanese economy.
Europe's sovereign problems have affected Japan through the yen's strength and stock price falls. As emerging economies that have close trading relations with Europe slow down, Japan's exports to those economies may decline, Shirakawa said.
The impact on the Japanese economy may grow bigger.
Japan's economy rebounded from a recession triggered by the March 11 earthquake and tsunami and grew 1.5 percent in the third quarter. But it is expected to slow sharply this quarter as the initial spurt driven by companies restoring supply chains and production facilities tails off.
With an expected boost from a $155 billion reconstruction budget passed this week still some months away, policymakers in Tokyo may feel pressure to help the economy again with yen-selling intervention and monetary policy easing.
The price data underscores the sluggishness of domestic demand as the economy's recovery has taken a breather because of a delay in reconstruction efforts and a global economic slowdown, said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo.
Finance Minister Jun Azumi pledged to shield exporters from sharp currency moves while expressing frustration with Europe's inability to contain the debt rout that has been driving nervous investors away from the euro and into more stable markets such as Japanese government debt.
It's really a shame because Europe's problems have started to intensify just when we were starting to see some bright signs on Japan's horizon, Azumi said.
The yen hovered around 77.35 yen against the dollar on Friday, having firmed gradually since Japan sold nearly $100 billion worth of yen last month, knocking it down from record a record high of 75.31 per dollar.
More gains threatening Japan's recovery could spur further action from the finance ministry and the BOJ. For now, however, Shirakawa stuck with the bank's view that rebuilding efforts from the devastating March 11 and continued growth in Japan's main export markets in Asia should help sustain moderate economic recovery.
The outlook on the BOJ's easing measures will depend largely on forex moves. Europe's debt problems are expected to be prolonged and the effects from Japan's intervention and the BOJ's easing steps may fade early next year, said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance.
So there is a chance of additional BOJ easing in January or February.
While the core consumer price index, which excludes volatile prices of fresh food, inched down for the first time in four months, the so-called core-core index, which also excludes energy prices and is similar to the core U.S. index, fell 1.0 percent in the year to October.
Core consumer prices in Tokyo, available a month before the nationwide data, fell 0.5 percent in the year to November, compared with the median estimate for a 0.3 percent annual decline.
Some economists say consumer prices could fall further in coming months as a slowing global economy dents oil prices, while deflationary pressures persist.
(Additional reporting by Rie Ishiguro, Writing by Tomasz Janowski; Editing by Edmund Klamann)