Tokyo: QNB said in its weekly report that there are significant opportunities for Japan’s economy to finally break free from its prolonged deflationary spiral. The bank said it expects inflation in Japan to persist for a longer period, allowing the Bank of Japan (BoJ) to continue its gradual process of interest rate normalization.
According to Qatar News Agency, the aftermath of the COVID-19 pandemic led to a surge in inflation rates across advanced economies, reaching levels unseen in decades. Following the pandemic and the Russia-Ukraine war, the supply shock caused by lockdown measures and geopolitical turmoil was coupled with a demand shock driven by unprecedented economic stimulus. This combination pushed inflation rates to multi-decade highs. Initially, Japan appeared to be an exception to this inflationary environment. However, as major central banks began raising interest rates to curb inflation widening the interest rate gap with Japan, the Japanese yen depreciated sharply, triggering a wave of price pressures in Japan as well.
The report added that the sharp depreciation of the yen increased global price pressures, pushing consumer inflation in Japan to a peak of 4.3% year-on-year in January 2023, which was its highest level in over three decades. The surge in inflation enabled the BoJ to exit negative interest rates for the first time in 17 years, having raised rates twice since then, though they remain at a low 0.5%.
Between 2023 and 2024, consumer price growth moderated, though it remained uncomfortably above the BoJ’s 2% target. This was due to the easing of international energy and commodity prices, and temporary government subsidies to households. However, price pressures returned sharply, with inflation rising to 3.7% in December 2023 and to 4% in January 2024, driven by rising domestic food prices, the gradual removal of government energy subsidies, and rising rent costs.
QNB noted that there was a big opportunity for the current environment to lift Japan out of its long-standing deflation. It expressed their view that there were three key factors that will keep inflation in Japan going for a while longer.
First, inflation data points to ongoing price increases and a shift in inflation expectations. Inflation has remained well above the BoJ’s 2% target for nearly three years. In a country where price stability was the norm, rising inflation is altering expectations, particularly among businesses and households. Surveys show that Japanese companies now expect inflation to average 2.3% over the next three years, well above the BoJ’s target. Renewed price pressures and shifting expectations indicate that inflation will remain elevated in the medium term.
Second, rising wages are improving household purchasing power, which is expected to support consumption and inflation. By mid-2024, real wage growth began to recover, driven by the Shunto negotiations, Japan’s annual wage talks between labor unions and corporate leaders, which resulted in average wage increases of 5.1% for the year, the highest in 33 years. This year’s negotiations are expected to lead to wage hikes of around 5.3%, further enhancing household purchasing power, boosting consumption, and adding upward pressure on prices. Additionally, these wage hikes are occurring amid labor shortages, increasing the likelihood that higher labor costs will be passed on to consumer prices.
Third, the government has introduced a fiscal program aimed at providing further economic stimulus, which will add additional inflationary pressure. The plan includes a record budget equivalent to $735 billion for the 2025 fiscal year and a supplementary stimulus package of about $90 billion. These measures include direct financial support to low-income households, subsidies to offset utility and energy costs, and raising the annual tax-free income threshold to encourage labor force participation. These expansionary fiscal policies are expected to increase inflationary pressures.
The note concluded by saying that inflation in Japan is expected to remain above the BoJ’s 2% target through early 2026, supported by ongoing price pressures, shifting expectations, rising wages, and expansive government fiscal programs. This environment will allow the BoJ to continue gradually normalizing interest rates, with at least one additional rate hike of 25 basis points anticipated this year.