Salary Increments To Decide Whether Japan’s Rate Hike Was On Point | The Reason Why

Has Japan become the new US? I can’t remember the last time Indian business media wrote so much about Japan. And I certainly didn’t expect to write this much about it either. This is my third column on Japan.

The Bank of Japan (BOJ) raised interest rates to 0.75% from 0.5%, the highest level in 30 years. Governor Kazuo Ueda said that wage growth was the key factor in this decision. So, let’s dig into this very factor.

Japan had been struggling with two major issues: deflation and declining fertility rates. Although it has made peace with some inflation, it hasn’t yet solved its fertility issue. That has a big impact on the economy and the labour market. It cannot raise the workforce until a certain point.

It has encouraged women to join the workforce, and now their labour force participation rate (78%) is comparable to that of European countries. Additionally, older folks have pushed their retirements forward and continued working. Now, it cannot mobilise more employees.

Companies are reporting labour shortage issues in almost every survey. Vacancies are ample, two for every job seeker. But there are no people to fill in those vacancies, leading to an increase in wages and salaries. That’s why companies agreed to wage hikes of 5% or more in the last two years, something unthinkable for most of the past three decades.

This brings us to Japan’s spring wage negotiations, known as Shunto. Every spring, Japan’s largest unions and companies negotiate wages simultaneously, setting the tone for the entire year across the economy. Even smaller companies follow them. This is why the BOJ watches spring negotiations more closely.

For the Japanese, a wage hike was great news. But that doesn’t make them happy because inflation is eating much of their incomes. The real wages, inflation-adjusted, have still been falling for the past three years because inflation has been rising faster than wages. That matters as it has pulled purchasing power down, impacting consumption growth.

Japanese firms say they will invest more in automation to cope with labour shortages. But productivity growth remains weak. In fiscal 2024, it rose just 0.2%, its best in four years, but still far below what is needed to support lasting real wage gains.

If wages rose faster than productivity, companies must either absorb higher costs or raise the selling prices of their products and services. Absorbing costs will hurt margins and may force them to cut investments.

Raising prices, on the other hand, will help them maintain profits, but will push overall inflation up. The BOJ hopes for the latter. It doesn’t want to fall back into deflation. But Japan’s history offers a warning. Companies don’t compete on margins.

Even when costs used to rise, many avoided passing them on to customers, fearing loss of market share. Companies still hesitate to increase prices aggressively, and consumers remain price sensitive after years of stagnant incomes.

There’s some good news, though. People are anticipating inflation to persist, which may help companies justify price increases. But here’s a contradictory side of the story. Although they expect prices to go up, they aren’t willing to spend much unless prices drop.

Now, that’s where the BOJ has taken a calculated risk. With a rate hike, they expect prices to cool down, reaching 2% target gradually. Then, it hopes wages to increase in the 2026 spring negotiations. If that happens, it can raise interest rates even more without choking growth. But the margin of error is thin.

If global growth slows, tariffs bite harsher, or firms turn cautious, wage growth could weaken. In that case, rate hikes would look premature. Ueda knows this. He is not declaring victory. He is testing whether Japan can live with slightly higher rates after decades of near-zero borrowing costs.

In addition, he understands the impact of unwinding of carry trade, weaker yen, subdued Japanese economy, and the ongoing tussle with the PM, who believes a rate hike is a “stupid idea”. So, this spring, if you are in Japan, your neighbour might not want your salary to rise, but Ueda is fully rooting for you.

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