TOKYO — China's official narrative that deflation is receding is gaining traction, but the underlying economic picture remains fragile. Consumer prices rose 1.2% year-on-year in May, while producer prices surged 3.9%, driven by higher costs for energy, semiconductors, and metals. For many economists, this marks the clearest signal yet that the deflation scare of 2025 is giving way to reflation.
Yet Japan's long battle with deflationary psychology underscores how difficult it is to break free from such a mindset. Beijing has yet to deliver the structural reforms needed to ensure the weak-price era is truly ending. Two critical areas stand out: resolving the deep housing crisis, which increasingly mirrors Japan's 1990s bad-loan spiral, and building a robust social safety net so that 1.4 billion citizens feel confident enough to spend rather than hoard savings.
Housing and Consumption: The Twin Pillars
These priorities are tightly linked. With roughly 70% of household wealth tied to property, stabilizing the real-estate market across China's 70 largest cities is essential for reviving consumption and sustaining 4.5% to 5% growth. But the longer President Xi Jinping's government acknowledges these pressures while avoiding decisive action, the more a deflationary mindset takes hold — and the harder it becomes to shake.
Japan serves as the cautionary tale. Even as the Bank of Japan prepares to lift rates to 1% next week — the farthest from zero in more than three decades — deflationary undercurrents still run through the economy. On paper, Japan looks like it has finally escaped its low-price trap. The BOJ expects inflation to reach 2.8% this year, suggesting reflation is taking hold. But beneath the headline, real wages remain negative, with pay packets consistently trailing price gains and domestic demand weakening as a result. The result is a slow-burn form of stagflation, and Tokyo has yet to deliver the structural reforms needed to close the gap between rising prices and stagnant household incomes.
“For the Japanese economy to fully break free from its long-standing deflationary mindset,” says Toshihiro Nagahama, economist at the Dai-ichi Life Research Institute, “it’s imperative for the government and the central bank to align, articulate their risk assessments, maintain honest and transparent dialogue with financial markets, and resolutely execute bold, long-term growth investments.”
Nagahama argues that today’s global economy is being shaped by an unusually dense intersection of forces — the war in Ukraine, volatility across the Middle East, and a series of historic turning points in central-bank policy. The common thread is unmistakable: geopolitics is now driving economic outcomes, not the other way around. With the Iran war on an uncertain path, he warns that governments cannot anchor their strategies to hopeful scenarios. They must instead plan around worst-case risks, including the possibility of a multi-year disruption in the Strait of Hormuz, a chokepoint that would reshape global energy flows and inflation dynamics.
“While these shifts present a formidable trial for Japan, they also represent a historic opportunity,” Nagahama notes. “As the country sheds its decades-long deflationary mindset and restores nominal growth, these external shocks serve as a critical test for fully escaping the paradigm of contracting equilibrium.”
Japan may not get the policy rethink it needs. Prime Minister Sanae Takaichi’s economic playbook still leans heavily on ultralow rates and a weak yen — the same formula Tokyo has relied on for nearly three decades. That is why next week’s expected BOJ rate hike to 1% is already irritating a political establishment that prefers monetary comfort to structural change. The timing is awkward: the June 16 meeting will proceed without Governor Kazuo Ueda, hospitalized with a liver infection. Yet, as Nomura economist Mari Iwashita notes, his absence is unlikely to alter the decision.
Even so, Takaichi’s camp is pressing the BOJ to ease off. Last year, she dismissed even the idea of rate hikes as “stupid,” despite mounting evidence that Japan’s 27-year experiment with zero rates has backfired. Her government is the 14th since the late 1990s to double down on a weak-yen strategy meant to lift exports and juice GDP. Instead of reviving Japan’s animal spirits, the approach dulled them. Decades of near-free money reduced the urgency for policymakers to boost competitiveness and for CEOs to innovate, restructure, and take risks. That complacency now shows: Japan Inc. is watching uneasily as BYD reshapes the global electric vehicle market and DeepSeek jolts the AI landscape — the kind of disruption Japanese firms once delivered in the 1980s.
Since taking office in October, Takaichi has shown little inclination to break from this script. “Sanaenomics” is essentially a continuation of Shinzo Abe’s playbook, built on the same reliance on ultralow rates and a deliberately weak yen. The problem is that Japan’s current bout of inflation is not the healthy, demand-driven kind policymakers once hoped for. It is being fueled by high import costs for energy, food, and other essentials — classic cost-push inflation, not the “demand-pull” gains that signal rising confidence. In short, it is bad inflation.
A similar dynamic is now confronting China. The gap between surging producer prices and muted consumer prices is the widest since June 2022. That divergence suggests manufacturers are struggling to pass higher input costs on to consumers, leaving profit margins under pressure. If that squeeze persists, it could have serious implications for wages across a $20 trillion economy, undermining household spending and complicating Beijing’s reflation narrative. This trajectory explains why Eurasia Group CEO Ian Bremmer entered 2026 warning that “China’s deflation trap” would not go away as easily as many hope.
For a deeper look at why forecasts of China's economic collapse often miss the mark, see The China Collapse That Never Arrives: Why Forecasts Keep Missing the Mark. Meanwhile, Beijing's recent crackdown on e-commerce price wars highlights the government's struggle to manage domestic demand, as covered in Beijing Cracks Down on E-Commerce Giants Over '618' Price War Tactics.
