(Originally published on February 16, 2024)

The Bank of Japan (BoJ) is being cautious about unwinding its ultraloose monetary policy as it waits for further evidence of a virtuous cycle of growth led by wage growth. The BoJ Governor Kazuo Ueda suggested that the degree of certainty is gradually rising, in a press conference on January 23, but Japan’s October to December 2023 real GDP shrunk by 0.1% compared to the previous quarter, undershooting market forecast that expected growth of approximately 1%. Weak household consumption and private investments led to the two consecutive quarters of real GDP decline.

✓ Wage growth may not be sufficient to boost real household consumption
✓ A 0.1% policy rate increase will not be detrimental to the Japanese economy, but additional rate increases are unlikely

Even if wages rise by 3%~4%, real household consumption may not increase while Japan’s inflation rate hovers in the 2%~3% range. Firstly, the disposable income of wage earners will increase slower than gross salary due to bracket creeping because income deductions and tax brackets do not automatically adjust for inflation in Japan. Secondly, consumption will grow more gradually than disposable income because households in their prime earning years typically save a large percentage of incremental disposable income growth for home purchases, children’s education, and retirement. In addition, households are accumulating cash to pay down their housing loans for when interest rates start to rise, as most housing loans in Japan have floating or fixed-to-floating interest rates.

Social benefit recipients tend to spend a more significant percentage of their disposable income, but real consumption growth will lag inflation because benefits are structured to increase slower than inflation to protect the national pension system.

On the other hand, the negative impact on the Japanese economy should be limited if the BoJ’s policy rate increase is limited to 0.1% because real interest rates will remain negative as the inflation rate hovers in the 2%~3% range.

Moreover, the short-term prime rate, which is used as the benchmark for most floating-rate housing loans and loans to small and medium-sized enterprises may not go up in tandem. As a precedent, the benchmark rate has remained unchanged at 1.475% since 2009 when the policy rate was 0.1%. Banks have also reduced their cost base so it may not be necessary to raise the rate.

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