Japanese wholesale prices fell for the first time in five years in December as the yen strengthened and the global economic downturn sent the cost of energy and raw materials tumbling.

The 0.2 per cent year-on-year decline in the country’s domestic corporate goods price index, announced on Thursday, came just five months after wholesale price inflation hit a 27-year high of 7.4 per cent.

While lower oil and materials prices are welcome in resource-poor Japan, declining wholesale prices will reinforce expectations that the recession-mired economy is set to succumb to an extended bout of deflation.

Gross domestic product data to be released next week are expected to show the Japanese economy contracted by about 3 per cent in the last quarter of 2008 – the equivalent of an annualised decline of 11.7 per cent.

Kazuo Momma, head of the Bank of Japan’s research and statistics department, warned this week that while the fourth quarter contraction might have been “unimaginable”, the fall in the current quarter “could be even greater”.

Falling oil and materials prices taken on their own should ease cost pressures on Japan’s battered manufacturers. But a dearth of demand, at home and abroad, means manufacturers are unlikely to feel much benefit in the short term.

Any gains are likely to be outweighed by the need to slash prices to entice buyers. Meanwhile, widening deflation could further damp domestic consumption, by encouraging already risk-shy consumers to hoard cash.

In December, Japan’s core consumer price inflation rate fell to an anaemic 0.2 per cent. January’s consumer price index for Tokyo – a lead indicator for national trends – showed that, with food and energy stripped out, consumer prices actually declined last month.

The BoJ has been relatively relaxed about the risk of a deflationary spiral, with Kiyohiko Nishimura, deputy governor, saying last month that the central bank had not yet seen a significant change in long-term price expectations among corporations and households.

Masaaki Shirakawa, BoJ governor, noted in an interview with the FT last year that Japan’s economic recovery between 2002-08 – the longest in the country’s postwar history – took place amid mild deflation.

Others are less sanguine and the spectre of deflation is likely to increase pressure on the central bank from politicians, government officials and analysts who believe it has responded too cautiously to the global economic slowdown.

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