The US-Japan tariff agreement fuels inflation, is the Bank of Japan's interest rate hike coming sooner?

Is the US-Japan tariff agreement a catalyst for a shift in the Bank of Japan's policy?

According to CCTV News, on July 22 local time, U.S. President Trump announced via social media that the U.S. and Japan had reached a trade agreement: a tariff rate of 15% on Japan and Japan's $550 billion investment in the U.S. Japan will open its national trade, including automobiles and trucks, rice, certain other agricultural products, and goods, and will invest $550 billion in the U.S., from which the U.S. will receive 90% of the profits.

According to news from the Wind Trading Desk, Barclays stated in a report on July 23 that the US-Japan tariff agreement significantly alleviated the tariff pressure faced by Japanese manufacturing, increasing the likelihood of achieving a wage increase of over 4.5% in next spring's wage negotiations, creating more favorable conditions for the Bank of Japan to achieve its 2% inflation target. Analysts have brought forward their expectations for a rate hike by the Bank of Japan from January next year to October this year based on this unexpected positive news and raised the GDP growth forecast for the fiscal year 2025 by 0.3 percentage points to 0.8%.

GDP Growth Forecast Raised by 0.3 Percentage Points

Previously, against the backdrop of the reciprocal tariff (effective tax rate of about 24%) announced in early April, Barclays had lowered Japan's growth forecast by 0.7 percentage points to 0.5%.

Analysts indicated that the downgrade was mainly due to reduced exports to the U.S., spillover effects on domestic manufacturing, delays in capital investment caused by uncertainty, and secondary effects from major economies like the U.S. and China.

However, after the new agreement was reached, U.S. tariffs on Japan were reduced to about 15%. Considering that Japan's opening of its market to U.S. goods means an increase in imports, and taking into account these positive factors, Barclays ultimately decided to raise its forecast.

Expectations for Rate Hike Brought Forward to October

Barclays believes that under the new tariff agreement, the Bank of Japan's expected rate hike may be brought forward from January next year to October this year.

The three major conditions for a rate hike set by analysts earlier this year included: 1) significant tariff reductions; 2) renewed depreciation pressure on the yen; 3) increased risk of the central bank falling behind the inflation situation.

Currently, the conditions for tariff reduction have been met, and coupled with the previously emphasized risk of inflation pressure exceeding the central bank's expectations, the probability of a rate hike by the Bank of Japan this year has increased.

Bank of Japan Vice Governor Masayoshi Amamiya also emphasized in a recent speech:

The tariff agreement is an important development that reduces the uncertainty facing the Japanese economy and increases the likelihood of achieving the 2% inflation target.

Significant Enhancement of Manufacturing Wage Increase Capability

Barclays emphasized that the impact of tariffs on next spring's annual wage negotiations will be significantly alleviated, which is a key focus for the Bank of Japan.

Analysis shows that even if Japanese manufacturing faces an average tariff of about 24% and a risk of appreciation of about 10 yen against the dollar, if the wage increase in the next fiscal year maintains the level of this fiscal year, its labor income share would only be about the average level since the global financial crisis, still having the capability to achieve considerable wage increases.

With the recent tariff agreement reached, the downward effect on corporate profits will be alleviated, and the rise in the share of labor income will further slow down. The likelihood of the manufacturing sector maintaining a positive stance on wage increases has increased. In addition, the non-manufacturing sector, which accounts for 75% of employment, is largely unaffected by tariffs and faces a more severe labor shortage than the manufacturing sector, thus demonstrating a strong willingness to raise wages.

Barclays has always believed that a wage increase of 4.5% or more is possible in next spring's negotiations, and the latest agreement further enhances this possibility