The Bank of Japan says broad-based wage growth is its main condition for “lift-off” from negative interest rates. As for Prime Minister Fumio Kishida, he has courted labour unions and made wage growth a pillar of his economic package.
Consumers want their wages to outpace inflation. Corporates are striving to oblige – and can tap record profits to pay their employees more.
This is the political and economic environment a few months before a key data point: wage survey results, which are expected in late March. This indicator will ultimately be key for the BOJ’s next move.
"Good inflation" versus a rising cost of living
As Kishida’s administration seeks wage growth, the prime minister has attended major union events and hired a former union official as an advisor. The government is considering tax breaks for companies that raise wages. Why?
- Voters are struggling to keep up with the highest effective inflation in over 40 years, led by food, as the following chart shows.
- Wage growth is central to Kishida’s “New Capitalism” concept of “growth and distribution.”
- “Good inflation” (as opposed to “bad” inflation driven by imported goods) would lead Japan out of its lost decades – a longtime goal of the BOJ.
The end of the "zero-inflation norm"
As I wrote in “Japan’s inflation revolution,” for almost three decades Japan was stuck in a “zero-inflation norm,” as former BOJ Governor Kuroda phrased it: consumers punished corporates that hiked prices, while not rewarding those who cut prices.
Thus, the optimal corporate strategy was to keep prices unchanged and minimizing wages to stay competitive. (The long-term effects were striking, as the next chart shows.)
The results of the corporate Tankan survey, displayed in the next chart, show how the zero-inflation norm has been breaking down. The net percentage of firms saying they are hiking prices remains near the highest level since 1980. And this shift is correlating with increased underlying (or “trimmed mean”) inflation.
The yen and imported inflation
The BOJ certainly hopes that the zero-inflation norm has been broken, and has cited the shrinking output gap (between the economy’s actual production and its potential) as a tailwind.
Yet, the central bank retains its negative interest rate policy (NIRP), and this “lower for longer” stance has driven the yen down to unbearable levels. (The yen has weakened 12 percent this year, hitting the psychologically important level of 150 per dollar.)
And as Japan imports over 80 percent of its energy and 70 percent of its calories, that has driven up overall prices for consumers.
For August, yearly growth in two of the BOJ’s three measures of underlying inflation surpassed 3 percent (the other was 1.8 percent). Meanwhile, the share of items within the Core CPI basket whose prices are rising has hit a record high of 86 percent, as the next graph shows1.
Consumers are struggling; some families have even started to cut back on education spending, NHK (Japan Broadcasting Corporation) has reported.
A potential yen intervention – and a warning from the Ministry of Finance
Given this stress on households, and with its approval ratings at risk, the government may have intervened in the foreign exchange market on October 3. The yen surged against the dollar.
While not confirming that any action took place, officials effectively communicated a warning shot after the spike. Traditionally, the scale of “excessive” currency fluctuation requiring action from authorities was believed to be an abrupt move over a day or week. This time, the Ministry of Finance effectively re-defined its intervention trigger, saying that a steady yen decline over a protracted period would also qualify for consideration.
With higher US yields and speculation about action from the BOJ, Japanese government yields are moving higher: investors are avoiding rate risk with regards to domestic government and corporate debt. Some prominent corporate new issues were forced to launch at the high end of their announced yield range.
In the third quarter, Japanese ten-year yields rose the most in twenty years, and hit a ten-year high of 0.77 percent (Nikkei, 10/6).
The bearishness in bond markets was worsened by the BOJ’s surprise yield curve control (YCC) tweaks in December 2022 and July 2023, where the ten-year yield cap was moved to 0.5 percent, and then effectively to 1 percent.
The current cap is reportedly justified by a modified Fisher hypothesis, which states that nominal rates should equal the real rate plus expected inflation. BOJ officials explain that an approximately 0 percent “neutral (or natural) rate,” plus their 2 percent inflation target, minus 1 percent for YCC, should equal about 1 percent: that’s where they set the cap. Press reports on Oct. 5 implied that Governor Ueda endorses this logic.
The next chart shows the YCC cap in the context of the Japanese yield curve more generally.
Is lift-off next?
This is the context for a debate about wage growth in Japan’s media that is almost deafening. One recent article (in Nikkei, 9/29) blasted this message: “corporates have saved enough;” “labour’s share of underlying profits is the lowest in 49 years;” and concluded with “wage growth is key to a sustained recovery.”
The same article also pointed out that corporate profits rose 12 percent to a record high in the second quarter, as the next chart shows.
As I have previously written, the tightest labour market in 30 years has prompted some companies to give forward guidance about the wages staff can expect through 2030.
The Nikkei newspaper’s “100 CEO Survey” showed that 71 percent of these corporate leaders ranked “investing in human capital” (including wages as well as reskilling) as the No. 1 key to increasing corporate value; that was well above the No. 2 priority – capital spending.
For the BOJ, data from RENGO, Japan’s largest labour organisation and the representative of about 5,000 unions, will be key. RENGO’s initial tally of results from wage talks should be released in late March, following a negotiation period that traditionally starts around February.
Long before he was the BOJ’s governor, Kazuo Ueda dissented from a previous “lift-off” from zero interest rates. A rate increase in August 2000 was followed by a slowdown and a quick policy reversal in the form of a rate cut by February 2001.
This time around, the governor has stressed that he is seeking “a virtuous cycle of wage and price inflation.” If the RENGO figures show high wage growth for FY2024 following the 30-year high seen for FY2023, this could finally be the trigger for the BOJ to end NIRP. In preparation, the central bank’s analysts are believed to be conducting their own private surveys on wage plans.
Post-script: a “Japanification” in China?
Amid the good times for corporate Japan, the outlook is clouded by the slowdown in China, a key trading partner. In recent years, Japan has been caught in the middle of trade tensions between the US and China: for instance, US import tariffs still apply to products produced by Japanese firms in China. Though President Biden has ratcheted down the rhetoric seen in the Trump era, tariffs on China average 19 percent versus 3 percent for the rest of the world.2
US officials also have noted that conditions for foreign companies in China have worsened following the expansion of an anti-espionage act that potentially restricts the information they can collect3.
These tensions are having an effect: in the second quarter, foreign investment in China plunged 82 percent from last year to the lowest level since 2000, as the next chart shows.
With Chinese growth and inflation both slowing, many observers are fretting about the “Japanification” of China. The timeline sounds too familiar: a trade war with the US, a burst real-estate bubble, worsening demographics and an economic slowdown.
China may be studying the post-1990s Japanese experience for lessons. The nation’s corporate executives have even visited management consultants in Tokyo to study how Japan coped, according to television commentators who visited China this summer.4