Deflation, the financial spectre that stalked Japanese industry for nearly a decade, may be returning to the world's second-biggest economy in a “perfect storm” of crashing commodity prices and a surging yen.

Fears of deflation are rising around the world, as the economic slowdown and the threat of deepening recession in the United States have hit the cost of raw materials.

The Baltic Dry Index - the principal gauge of what it costs to move materials around the world - has tumbled by 95 per cent since its highs earlier in the year. Manufacturers are struggling to push through price increases as commodity prices fall and a strong yen has boosted the buying power of retailers, pushing down prices on the Japanese high street.

The return of deflation to the Japanese economy would come within 18 months of its supposed slaying last year. Japan's long era of deflation, when prices were static or falling despite the ultra-low cost of borrowing, dented the national appetite for risk and investment. Since 1998, the challenge of stimulating consumer spending, capital expenditure and price rises has obsessed Japan's financial authorities: many believe that the economy is inherently geared towards the phenomenon and that it was resolved only because of record commodity and energy price inflation.

With the key input prices in freefall, the deflationary spiral - whereby manufacturers find it difficult to raise prices - appears set to begin again. The slowdown in China's construction and manufacturing growth is contributing to lower commodity prices and is prompting manufacturers to lower prices of finished goods as competition intensifies.

Many deflationary examples are emerging in Japan. Steelmakers, who were able to pass 30 per cent price rises on to carmakers and other manufacturers this year, are being hounded by customers for price cuts after iron ore and silicomanganese spot prices tumbled. Prices of steel plates and some large construction joists have fallen by more than 30 per cent in recent weeks. The glass industry has raised sheet glass prices for use in buildings and cars by about 15 per cent for the first time since 2000, but more rises are now unlikely.

For more than five years, Japanese chemicals, fibre and specialist plastic manufacturers have been hammering at their corporate customers to accept higher prices, but falling oil and hydrocarbon prices have taken the punch out of their bargaining power.

The price-cutting spiral is evident in Japan's electronics industry. Within the past two weeks, the price of a 32in LCD panel has fallen by an average of 8.7 per cent. A 17in screen - of the sort used to make a PC monitor - costs half what it did in the summer.

On the high street, sales are rising at cheap clothes shops while the strong yen has boosted the buying power of department stores and luxury goods retailers. The yen's surge is being passed on to customers in the form of discounted Louis Vuitton bags. Good for consumers, but, analysts say, bad for retailers and the economy.

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