BoJ Sees Broadening Wage Hikes, Signals Potential Rate Increase

The Bank of Japan (BOJ) has observed a broadening of wage hikes across the economy due to tight labour market conditions, signalling progress toward its 2% inflation target. This optimistic assessment, made at the BOJ’s quarterly meeting of regional branch managers on Monday, strengthens the case for a potential interest rate increase at its next meeting on July 30-31.

Recent data shows that Japanese workers experienced a 2.5% rise in average base pay in May, the fastest pace in 31 years. This increase in wages is expected to enhance household purchasing power and support consumption. The BOJ noted that large firms’ significant pay hikes during this year’s wage negotiations are spreading to small and medium-sized enterprises (SMEs).

The assessment marks a shift from the previous meeting in April when the BOJ saw “hopeful signs” of wage increases among big companies spreading to smaller firms. Some smaller regional firms are prioritising wage increases to attract and retain workers, despite not earning sufficient profits. This reflects the intensifying labour shortage due to Japan’s shrinking working-age population.

Many companies, especially in the services sector, are starting to pass on rising costs by raising service prices. Kazushige Kamiyama, the BOJ’s Osaka branch manager, noted that higher wages mean higher costs for firms, prompting some to increase service prices.

The central bank’s view on wage developments will be crucial in setting interest rates and updating quarterly growth and inflation projections at this month’s policy meeting. BOJ Governor Kazuo Ueda has emphasised the need for wage hikes to extend to smaller firms and for companies to begin charging more for services before considering raising interest rates from current near-zero levels.

Market expectations are mixed, with many anticipating a rate hike sometime this year but divided on the timing. Despite rising living costs squeezing domestic household spending, the BOJ remains optimistic about consumption, bolstered by a surge in inbound tourism.

A government survey showed improved sentiment among service-sector firms in June for the first time in four months, driven mainly by tourism. However, rising inflation has led consumers to seek cheaper goods, particularly at supermarkets. Household spending fell unexpectedly in May, with higher prices continuing to erode purchasing power. Although analysts expect real wages to improve in the coming months, the yen’s recent decline could increase import costs.

Core consumer prices in May rose 2.5% from a year earlier, staying above the BOJ’s target for more than two years.