Japan’s growing inflation problem exposing BOJ’s policy errors

With Japan’s powerful business federation, or Keidanren urging its member firms to raise pay in the next round of salary negotiations in spring to try to offset rising inflation that is eating into household incomes, we think the stage is set for higher wage hikes from April which BOJ has long outlined as a precondition for it to abandon its ultra-loose monetary policy and yield curve controls. This combined with rising minimum wages urged by Japan’s government should only add momentum to this impetus. 

As we have argued for much of this year, Japan’s fast ageing demographics is a key structural issue that will keep its labour market very tight in the coming term as Covid restrictions are abandoned. Indeed, since Japan’s borders have reopened last month, we are already hearing that that the huge influx of overseas tourists, partly helped by weak yen which has made Japan a cheap holiday destination is sending the hospitality sector scrambling for more staff to cope with this surge. 

As we have also explained, similar to Western economies where firms have struggled with retaining staff and wage inflation in the service sector as consumer spending has shifted away from goods to services, we are likely to see this phenomenon play out in Japan where labour is even more scarce and immigration rules fairly restrictive in allowing young blood into its economy. In fact, we hear that weaker yen itself has made Japan a less ideal destination for foreign workers. 

All this means that wage inflation in services which made up over 70% of Japan’s work force distribution pre-Covid is likely to become a big problem. This is ironic as BOJ has argued that it is unlikely to pivot in its monetary policy until wages start to show signs of recovery. Indeed, its outgoing chief, Kuroda-san has predicted that Japan’s inflation rate which has consistently overshot its expectations this year, is likely to fall back from next April.

We believe this a convenient timeline when Kuroda’s term as the BOJ chief comes to an end, leaving the calamity facing Japan’s sovereign bond market from the central bank’s inevitable policy exit to the next governor. Indeed, we think Kuroda will prove dead wrong once again as household bills are likely to rise even further next year as the lagging impact of weaker yen has yet to be fully felt on import bills. 

It is also worth noting that Japan’s utility firms are now seeking permission to raise regulated power rates next April, representing the first hikes since the war in eastern Europe and the power crisis began. This raises more questions about such a benign BOJ inflation outlook which Kuroda has totally failed to elaborate on, sticking to his ‘transitional inflation’ argument that most central bankers have long abandoned.  

We also believe that government’s $200bn supplementary budget of subsidies, all financed by its borrowings to tackle rising prices for households will prove unsustainable to permanently tame Japan’s inflation. Indeed, questions about government’s own fiscal stimulus exit strategy in the face of Japan’s ballooning budget deficit is already looming, leaving JGBs even more vulnerable to BOJ’s inevitable policy pivot that could make the recent gilt market crisis in the UK look like a blip in comparison.