Notwithstanding improvement in margins and wages for large companies, BoJ to wait until it completes its monetary review

The Bank of Japan (BoJ) has begun to highlight the rising inflation bias. At the Lower House, Governor Ueda testified on June 9th that corporate price-setting behavior has been shifting upward. Furthermore, as the spring wage negotiation resulted in the largest wage increase in 30 years, inflation could surprise on the upside.

Price transfer of higher input costs has become broad based. For sure, small companies, which tend to have a low bargaining power in price setting, appear to have begun to raise their output prices. In fact, their profit rate sharply improved from 2.3% in Q3-22 to 4.3% in Q1-23 (Chart 1). However, this increase has arguably been a reversion to the mean, and it is not generalized as the profit rate for all Japanese companies has been rather flat. Therefore, these developments don’t allow sufficient room for substantial wage hikes, at least not yet.

In fact, wage growth has remained weak, despite the successful spring wage negotiation. Wages among major firms rose by +3.7% in FY2023, the largest increase in 30 years, which should become effective from the new fiscal year from April. However, overall wage growth was limited to +1.0% YoY in April (Chart 2). While a timing issue could be behind this disappointing result, this could suggest that SMEs which generate about 70% of Japan’s employment has been facing challenges to raise wages.?

Given the above, inflation could end up being transitory, unless SMEs improve their productivity and raise wages. As we discussed in our previous report*, stagnating productivity gains among SMEs have so far contained their profitability and wage growth and this has not really changed lately. On the other hand, import prices, which were the major driver of Japan’s inflation, have begun to decline for the first time in two years since April. Therefore, as price transfer of higher input prices is completed, inflation could soften once again.

Therefore, the BoJ’s commitment to achieve the 2% inflation target is not yet guaranteed. Overall wage development hasn’t been strong enough to meet the target even if inflation expectations have remained elevated. With this background, the BoJ signaled at the April meeting that it would remain on hold, but it did announce it would undergo a thorough review of its monetary policy, which would take 1 or 1.5 years. It seems unlikely that the BoJ will change its stance before this review is fully completed unless overall wages really surprise on the upside in a sustainable manner.

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