Japan’s inflation is no longer a theory. It is finally a reality.
For decades, the country struggled with deflation, where prices stayed flat or fell, wages barely moved, and companies hoarded cash.
Now, inflation has returned, and Japan is trying to adapt.
Wages are rising, the Bank of Japan (BOJ) has lifted interest rates, and businesses are restructuring.
But is this the start of something new, or just another phase in a long economic cycle?
Wages are rising, but are they enough?
Large Japanese companies have raised wages for the third consecutive year.
Hitachi approved a 6.2% increase, Toyota matched last year’s rise, and analysts estimate an average increase of 5% to 5.5% across major firms.
This is the highest wage growth in three decades.
The country’s biggest labor union, Rengo, is pushing for even higher pay hikes, calling for a 6.09% increase this year.
The Bank of Japan sees this as a positive sign.
If wages keep rising, households could spend more, boosting demand and breaking Japan out of its long deflationary mindset.
But real wages, which are adjusted for inflation, are still falling.
In 2024, they dropped by 0.2%, meaning that despite bigger paychecks, people aren’t better off.
Instead of spending more, Japanese households are cutting back.
The government reports that people are eating fewer vegetables than at any time since 2001.
The Engel coefficient, which measures how much of household income goes to food, has hit a 43-year high.
This suggests Japan may be facing the wrong kind of inflation.
Perhaps one that makes everyday life more expensive but doesn’t create strong economic momentum.
The BOJ is raising rates, but how far can it go?
For years, Japan kept interest rates near zero, even negative at times, to encourage borrowing and investment.
But that changed in 2024.
The BOJ ended its negative rate policy for the first time in 17 years and has since raised rates to 0.5%.
More hikes are expected, possibly bringing rates to 1.25% or higher in the coming years.
Markets expect further hikes, with projections suggesting rates could reach 1.25% to 1.5% in the coming years.
However, higher rates come with risks. When the BOJ increased rates by just 0.25% in July 2024, Tokyo’s stock market saw its worst single-day drop on record.
Higher rates also make borrowing more expensive, which could slow business investment.
Many Japanese companies, already hesitant about long-term domestic growth, are focusing their investments abroad rather than in Japan.
At the same time, a weaker yen, partly caused by Japan’s large trade deficit and corporate investments overseas, continues to push up import prices, keeping inflation high.
This puts the BOJ in a difficult position: raise rates too fast, and it could slow growth; move too slowly, and inflation could spiral further.
Troubles in the corporate environment
Demographics is one of the biggest forces shaping Japan’s economy.
The country’s population is shrinking at an unprecedented rate, losing an average of two people per minute.
This has created severe labor shortages, which are a major reason companies are raising wages.
At the same time, businesses are skeptical about Japan’s long-term growth potential.
Instead of reinvesting domestically, they are expanding overseas, seeking growth in foreign markets rather than betting on Japan’s inflation-driven recovery.
For years, Japanese firms have been reluctant to make big structural changes.
But more recently, companies are selling off non-core assets, automating operations, and cutting unprofitable divisions.
The Tokyo Stock Exchange has seen a net decline in listed companies for the first time in years as mergers, acquisitions, and delistings accelerate.
This hesitancy is a major problem for Japan’s economic recovery.
If businesses don’t believe in the domestic market, wage hikes may remain selective rather than widespread, limiting the impact on demand.
What’s next for Japan?
The BOJ argues that Japan’s inflation is sustainable.
Wholesale inflation, which measures the cost of goods between businesses, remains at 4%, showing that price pressures are still strong.
The core inflation rate, which excludes fresh food and energy, has held above 2% for nearly three years, a key signal that inflation may be sticking.
But households aren’t convinced. Consumption is weak, and many people still expect inflation to slow down in the long run.
If that happens, wage growth could stall, businesses could cut back on investment, and Japan could find itself back in a low-growth cycle.
The BOJ will meet again next week to decide on its next move.
Some economists believe another 0.25% rate hike could come as early as May, while others think the BOJ will wait until the summer.
Either way, this is not an easy decision.
Raising rates too fast will hurt growth, while waiting too long could let inflation spiral out of control.
The BOJ and government argue that Japan is finally breaking free from decades of deflation.
But under the surface, consumer spending is weak, companies are still hesitant to invest in Japan, and the stock market is volatile.
There is also the risk that inflation is being driven by external factors, such as global energy prices and a weak yen.
Rather than genuine domestic growth. If these pressures ease, inflation could fall back, leaving Japan with sluggish demand and stagnant wages once again.
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