Japan marked nine months of deflation in November with increasing signs that weak demand is hitting prices, adding to the political pressure on the Bank of Japan (BOJ) for further monetary easing.
While the pace of falling prices slowed in the year to November as the effect of oil price falls faded, that offers little solace to policymakers worried about the risk of another recession.
An index stripping out both energy and food prices fell at a near-record pace, showing weak final demand was playing an increasing part in pushing down prices.
"No one thinks deflation will end soon and today's data won't change that perception," said Naoki Murakami, chief economist at Monex Securities.
With Japan's huge public debt limiting room for additional fiscal stimulus, the government may push the BOJ to ease monetary policy further next year, analysts say, such as by increasing its purchases of government bonds.
"Japan's public finances are the worst among developed nations, so the risk of a credit downgrade next year is real," said Yasuhide Yajima, a senior economist at NLI Research Institute.
"The government will surely pressure the BOJ to do more such as boosting its public debt purchases. The central bank might be reluctant to do so but won't have much choice but to comply."
An inflation index that excludes food and energy prices and is similar to the main index used in the United States, fell 1.0% in November from a year earlier, near a record 1.1% drop hit in October.
Japan's core consumer price index, which includes oil products but excludes volatile fresh fruit, vegetables and seafood, matched a median market forecast of a 1.7% drop.
That was less than a 2.2% fall in the year to October, as a big slide in oil prices eases.
The government and the BOJ have clashed over how to deal with deflation, which the central bank forecasts will last at least three years, as policymakers fret it could drag down the economy just as it is emerging from the global financial crisis.
The BOJ buckled this month, calling an emergency meeting to announce a new short-term funding facility and last week underlined its deflation-fighting credentials by declaring it would tolerate nothing but price growth.
The BOJ's commitment to low rates has put steepening pressure on the government bond yield curve, pinning down shorter-dated yields while longer-dated yields drift higher on concern over Japan's worsening finances.
The five-to-20-year yield spread this week has hovered near a decade high 165 basis points struck last week.
The Democratic Party-led government, in office for three months, is determined to keep the economy from slipping back into recession ahead of an election for parliament''s upper house in mid-2010.
But with Japan's public debt nearing 200 percent of GDP and markets jittery over the risk of a glut of new bonds, it has cut spending plans for next year's budget, set to be unveiled on Friday.
The spending cuts may help the government achieve its self-imposed cap on new bond sales for next fiscal year of 44 trillion yen ($481 billion). It risks a downgrade by Fitch ratings if it borrows much more in fresh issuance.
Cutting spending, however, also carries risks for an economy barely emerging from the previous recession.
While the BOJ has said there is little more it can do with interest rates near zero, it may come under pressure for more action next year if Japan slips into recession or renewed worry about soaring public debt pushes up bond yields, analysts say.
The central bank is reluctant to increase its outright purchases of long-term government bonds from the current 21.6 trillion yen per year, arguing that its balance of bond holdings is already near a self-imposed ceiling.
