Of all advanced economies, Japan may have undergone the most remarkable structural change in the post-pandemic cycle.
After a 12-year run of negative policy rates, the Bank of Japan has ended the experiment and moved settings into positive territory.
Japanese workers have enjoyed income gains, with wage negotiations yielding raises that have kept pace with inflation. Rising incomes will help to fuel a cycle led by consumer spending. Consumption will be important as the outlook for exports is impaired: trade tensions are the new normal, demand from Europe and China is weak, and the U.S. is threatening a bevy of increased tariffs.
Japan’s currency has had a volatile year and is currently weak. A cheaper yen will support more inbound tourism, but the volatility will limit investor interest in the nation.
Japan has not fully overcome its fundamental weaknesses.
The forces that constrained Japan before the pandemic have not been conquered. The nation has an aging population, few births and little immigration. Though its labor market features high rates of employment, turnover is low and productivity gains are minimal. Its Treasury is dependent on continual debt purchases by the central bank, which owns the majority of outstanding Japanese government bonds. Quantitative tightening will only reduce debt monetization, not eliminate it. Japan’s exports face relentless competition from China, Korea and other growing Asian competitors.
The election near the end of 2024 illustrated some discontent among the population. Though low on a relative basis, the return to inflation was disconcerting and motivated voters to change their ruling coalition.
In the year ahead, we expect Japan to settle into a steady state that is better than its old stasis. Wage gains are likely to remain positive, though less substantial than in 2024; higher rates wages will keep some upward pressure on inflation. The Bank of Japan will find room for one more rate hike, but structural limitations will leave little headroom for rates to rise further.
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