Japan's real wages unexpectedly recorded the largest decline since September 2023, but expectations for interest rate hikes by the central bank remain undisturbed

According to Zhitong Finance APP, as Japan's inflation continues to outpace wage growth, the real wages of Japanese workers have seen their largest decline since September 2023, presenting a growing economic growth challenge for Prime Minister Shigeru Ishiba just about two weeks ahead of a key election. A relatively positive piece of news for Ishiba's government and the Bank of Japan, which is seeking to advance the interest rate hike process, is that Japan's largest labor union group, Rengo, announced last Thursday that Japanese companies have agreed to raise wages by 5.25% this year, marking the largest increase in 34 years. Under the dual pressures of inflation and labor shortages, sustained wage increases have become a new norm that companies must face.

Data released by Japan's Ministry of Health, Labour and Welfare on Monday showed that real wages in Japan fell by 2.9% year-on-year in May, while economists had generally expected a decline of 1.7%. During the same period, nominal wages in Japan only increased by 1% year-on-year due to reduced bonuses, a growth rate far below economists' estimates.

Although the decline in real wages indicates that Japanese voters are feeling the pinch ahead of the crucial Japanese Senate election on July 20, the robust growth in basic wages driven by inflation and labor shortages has led the Bank of Japan to continue considering further interest rate hikes.

The unexpected sharp drop in real wages highlights the strong expansion of inflation in Japan, adding pressure on the ruling coalition ahead of the Senate elections. As prices continue to rise faster than wage increases in Japan, public dissatisfaction is growing, forcing politicians to come up with more convincing livelihood relief plans.

Sota Takano, a senior economist at Itochu Research Institute, stated, "In the current election campaign, candidates often cite the real wage data from this monthly report. Today's results show that the public is feeling significant pressure from the cost of living—this is undoubtedly a frustrating outcome for Ishiba."

Japan's core inflation rate in May was 3.7%, far exceeding the Bank of Japan's target of 2%. The widespread price increases of essential goods such as food and services are the main drivers.

With only two weeks until the voting day, Ishiba's ruling Liberal Democratic Party has already promised to distribute approximately 20,000 yen (about 138 USD) in cash to each adult and has introduced more measures to stimulate wage growth. However, the latest polls indicate that this one-time subsidy is not popular, with many voters leaning towards supporting the opposition's proposal to cut the consumption tax.

In terms of monetary policy, although the weakness in real wages is concerning, the continuous increase in nominal wages and basic wages, along with inflation exceeding expectations, may give the Bank of Japan room to continue considering interest rate hikes. The central bank is closely monitoring wage and price dynamics to assess the timing of its next monetary policy actions, especially against the backdrop of uncertainties regarding U.S. tariffs impacting global economic growth.

The report released on Monday showed that Japan's basic wages grew by 2.1% more than expected; at the same time, a more stable indicator that excludes bonuses and overtime pay—salaries for full-time employees—rose by 2.4%, remaining above a 2% growth rate for nearly two years The next policy decision by the Bank of Japan will be announced on July 31, and the market generally expects its benchmark interest rate to remain unchanged at 0.5%.

"Despite the unexpected slowdown in the overall growth rate of cash earnings in Japan in May, the details still indicate that the pace of wage growth remains solid. The fluctuations in special cash earnings (such as one-time bonuses) and the fewer working days in several industries—likely affected by calendar effects—have dragged down the headline data," said economist Taro Kimura from Bloomberg Economics.

Looking ahead, after strong results in this year's spring labor negotiations, wage momentum is expected to continue expanding. The final statistics from Japan's largest labor union federation, Rengo, show that workers received an average pay increase of 5.25%, the largest rise in 34 years. These increases cover about 10% of Japan's workforce, particularly encompassing the vast majority of large Japanese companies, and are expected to be more evident in the summer wage data.

A major driver of current wage growth is the structural labor shortage, prompting companies to raise wages to attract and retain talent. Rengo's statistics indicate that sectors such as information technology have seen the highest pay increases due to the extreme shortage of software engineers.

However, uncertainty surrounding U.S. tariff policies also poses risks to wage momentum, as higher tariffs could squeeze corporate profits and weaken the ability to continue raising wages. In its latest economic outlook report, the Bank of Japan warned that U.S. tariff policies could particularly impact large domestic manufacturers in Japan, which typically play a bellwether role in nationwide wage negotiations.

Takano from Itochu Research Institute stated, "There is no doubt that large manufacturing companies in Japan, such as automakers, will face a more challenging situation. While the pace of wage growth this fiscal year appears to be steadily advancing, we need to be cautious about whether companies can maintain the same level of pay increases in the next round of negotiations."

Expectations for a rate hike by the Bank of Japan have not been disturbed by the unexpected decline in actual wages; stable and sustainable basic wage growth is crucial for maintaining a consumption-driven recovery, which is also one of the core prerequisites for the Bank of Japan to resume rate hikes. Survey data shows that just over half of economists expect the Bank of Japan's next 25 basis point rate hike to occur at the end of this year or in early 2026