Japan is poised to exit more than a decade of deflation as a strengthening yuan bolsters China's buying power, fueling Japanese production and buoying prices, according to Nomura Holdings Inc. (8604) Demand from China will propel continuous gains in Japanese consumer prices next year as companies ramp up production with factories now running at about three quarters of capacity, Takahide Kiuchi, Nomura's chief economist, said in an interview on April 13.

The yuan has gained 5.2 percent against the yen this year, making Japanese products more affordable in China, which became Japan's biggest overseas market in 2009. Enlarge image Deflation End Near for Japan on China Buying Power Deflation End Near for Japan on China Buying Power Deflation End Near for Japan on China Buying Power

Kiyoshi Ota/Bloomberg

Pedestrians and shoppers walk past commercial buildings in the Ginza district of Tokyo. Consumer prices excluding fresh food unexpectedly rose 0.1 percent in February from a year earlier, the first gain in five months, the statistics bureau said on March 30.

Pedestrians and shoppers walk past commercial buildings in the Ginza district of Tokyo. Consumer prices excluding fresh food unexpectedly rose 0.1 percent in February from a year earlier, the first gain in five months, the statistics bureau said on March 30. Photographer: Kiyoshi Ota/Bloomberg

Premier Wen Jiabao last month said China will adopt policies to encourage domestic consumption and wean the country from its dependence on exports. The shift may help Japan absorb a glut of unused factory capacity and unwind a cycle of declining prices that has weighed on economic growth. Deflation has driven wages down 16 percent since a 1997 peak and caused tax revenues to fall by about 20 percent in the same period, according to government data compiled by Bloomberg.

"Even mild deflation is a bad thing," Kiuchi said. "When people expect deflation, wages tend to decline more rapidly. That means real wages decline and that undermines consumption."

Japanese companies are using about 73 percent of their factory capacity, according to trade ministry data released yesterday. An increase in capacity utilization to about 85 percent in August 2007 preceded Japan's last period of inflation, a 15-month stretch of price gains between October 2007 and December 2008.