Prospect of wage growth still challenging for households, BOJ

Japanese firms look increasingly set to raise wages in 2024 at a pace that would at least keep the upward momentum seen in the previous year intact, though it may take some time, well into the year, for consumers to feel the actual benefits of higher wages due to inflation.

That bodes ill for Prime Minister Fumio Kishida who is seeking to help ordinary people cope with the current cost-of-living crisis with inflation-relief measures. Amid market expectations of the Bank of Japan moving to normalize monetary policy as early as January, the months ahead will be challenging if the country shifts to "a world of interest rates."

The BOJ, which currently keeps borrowing costs at rock-bottom levels, is waiting to see whether wage growth will accelerate to set the stage for its 2 percent inflation target to be achieved stably. But its nine-member Policy Board appears divided over the need to prepare for an exit from aggressive monetary easing.

The onus is on Japanese firms that have earned record profits, helped by a historically weak yen, and passed on increased costs to consumers while rewarding their workers with more pay hikes. Severe labor shortages, especially in the services sector hit hard by the COVID-19 pandemic, are considered to be boosting wages as companies need to pay more to secure enough workers, which in turn would support inflation expectations, analysts said.

"The final step toward monetary policy normalization will be the termination of short-term negative rates," said Martin Schulz, chief economist at Fujitsu Ltd.

"To finally get into sync with other major central banks again and to avoid a destabilizing impact on the yen exchange rate, this has to be done in early 2024 before the (Federal Reserve) starts lowering rates in the United States," he added.

Short-term interest rates are currently maintained at minus 0.1 percent, while the BOJ now allows the 10-year Japanese government bond yield to rise above the previously rigid ceiling of 1.0 percent, following a recent series of policy tweaks. The negative rate policy was introduced in 2016.

"With the economy slowing on weaker demand and high inflation receding, the impact on long-term yields will be quite low. We should not expect 10-year yields rising significantly above 1.0 percent during the normalization period," Schulz said.

Eyes are on the upcoming "shunto" wage negotiations between management and labor unions in early 2024, partly because BOJ Governor Kazuo Ueda said he wants to see salaries increase "markedly" and that the outcome of the talks will hold the key.

Major think tanks say wage growth will accelerate from 3.6 percent in 2023, the fastest pace in three decades.

Mizuho Research & Technologies expects an average 3.8 percent increase while Dai-ichi Life Research Institute projects a 3.7 percent gain. Itochu Research Institute forecasts a rise of 4.1 percent.

Ahead of the closely-watched negotiations, Kishida asked business leaders to raise wages "at a faster pace" in 2024 than the previous year, saying that Japan stands at a critical turning point in its longstanding fight to break with deflation.

"The prevailing mood is clearly for raising (wages) but there are companies that won't be able to keep up with the trend, depending on the size and sector," said Shinichiro Kobayashi, a senior economist at Mitsubishi UFJ Research and Consulting. He pointed to winter bonuses growing slower than the pace of inflation, at 1.37 percent for large firms, as an underwhelming outcome.

High-paced wage growth, even if it happens, would only have a limited positive impact on private consumption. One key indicator is whether real wages, which fell for 19 months to October, will turn upward to the benefit of households.

Kobayashi and other economists expect inflation-adjusted wages to rise in the latter half of fiscal 2024.

"We need to wait until around summer if we are to confirm the impact of shunto negotiations in economic indicators. But if financial markets are anticipating and factoring in a BOJ policy shift, it would be a way for the BOJ to do it early," Kobayashi said.

In fact, real wages being stuck in negative territory may not dissuade the BOJ from normalizing its policy, after Governor Ueda said the central bank can move if it can foresee a "turnaround."

The BOJ currently expects core consumer prices, which exclude volatile fresh food, to rise 2.8 percent in fiscal 2024 from a year earlier and then increase 1.7 percent in fiscal 2025 as the effects of higher import costs, inflated by a weaker yen, wear off. It is expected to release its fiscal 2026 outlook in April.

Former BOJ board member Takahide Kiuchi is skeptical that inflation expectations will remain heightened. "For the BOJ to reach a point where it can raise its policy rate substantially, the potential growth rate of the Japanese economy should rise as a prerequisite," said Kiuchi, executive economist at Nomura Research Institute.

Japan's potential growth rate has been around zero percent, despite its economy likely growing by around 2 percent in 2023. That pace of growth will slow sharply to 0.78 percent in 2024, according to private-sector economists polled by the Japan Center for Economic Research.

In December, BOJ Deputy Governor Ryozo Himino said in a speech that there are merits to rising interest rates for households and companies, such as higher deposit rates, underscoring that it is possible that an exit from its large-scale monetary easing will lead to positive results.

His boss Ueda also told business leaders that the BOJ will consider changing policy if the likelihood of attaining 2 percent inflation stably rises "sufficiently," after the country's powerful business lobby called for policy normalization at an early date.

"What the BOJ would do is to shift from 'unusual' monetary easing to a more normal one," said Kobayashi of Mitsubishi UFJ Research.