The Bank of Japan is increasingly blaming chronic labour shortages, not stagnant demand, as the main reason for its weak economic activity, a justification it may use to lift interest rates beyond what was initially expected.
From factories to hotels to restaurants, Japanese businesses are struggling to hit full capacity not because they can’t find customers but because they can’t find workers, goes the commentary now emerging more from the central bank.
While the tight labour market is not a new trend, the BOJ’s more vocal concerns about the resulting wage and inflationary pressures mean it will be more inclined to look past economic weakness as it considers raising interest rates further, analysts and policymakers say.
“My view is that … the output gap is already in positive territory in reality and the lack of supply capacity is exerting upward pressure on prices,” Naoki Tamura, a hawkish BOJ board member, said on Thursday.
On paper, Japan’s output gap, which measures whether the economy is running at its full potential, remains slightly negative, suggesting demand lacks momentum to ignite inflation. Coupled with soft consumption, it has been seen by analysts as a factor that could discourage the central bank from raising borrowing costs too much.
But BOJ policymakers are challenging that narrative.
A close look at the BOJ’s quarterly outlook report published in January shows the bank turning more attention to growing signs wage-driven inflation is taking hold due to chronic labour shortages, in turn building the case for sustained, steady rate hikes.
In that report, the BOJ said a dwindling pool of female and elderly workers meant labour market conditions are tightening even amid subdued economic growth.
“In this situation, upward pressure on wages and prices is likely to be stronger than suggested by the output gap, given that firms in many industries have started to face labour supply constraints,” the report said.
The report also analysed how labour-intensive sectors such as construction and services were facing serious worker shortages that were curtailing activity.
The BOJ’s increasing focus on wage-driven inflation is another sign Japan is shedding its 25-year battle with deflation and economic stagnation. It also contrasts with former Governor Haruhiko Kuroda’s insistence on using radical stimulus to fire up inflation.
“The BOJ is becoming more convinced that wages and services prices will keep rising,” said former BOJ top economist Seisaku Kameda, who is now executive economist at Sompo Institute Plus.
“Its report, the language of its policy statement and the governor’s comments all back up the case for more rate hikes.”
Mindful of the risk of an inflation overshoot, BOJ board members debated the chance of further interest rate hikes even after raising short-term rates to 0.5%, a summary of opinions at the January meeting showed.
One opinion cited labour shortages as keeping inflation elevated, while another warned of the risk of “stagflation,” where high inflation and low growth co-exist, the summary showed.
The BOJ’s hawkish tilt means markets may put greater focus on the bank’s language around wage-driven inflation, rather than its views on consumption.
“The BOJ is becoming increasingly mindful of how labour market conditions could be putting upward pressure on wages and prices, more than what its output gap estimate suggests,” said Ryutaro Kono, chief Japan economist at BNP Paribas.
“While the initial factor may have been the weak yen, the BOJ is beginning to recognise the risk of price rises turning into home-made inflation,” he added.
PERSISTENT PAIN
Japan’s rapidly ageing population has led to a dwindling pool of workers. The country faces a deficit of 3.4 million workers by the end of this decade and 11 million by 2040, according to a 2023 study by Recruit Works Institute.
Kushikatsu Tanaka Holdings, which runs a restaurant chain nationwide, is among retailers suffering from chronic labour shortages, particularly in regional areas.
“It’s not as if we’re suddenly facing shortage of staff – it’s a permanent issue,” an executive of the company told reporters.
“In regional areas, it’s not even about hourly pay. There’s a lack of people in the first place. We’re trying to consolidate our outlets and shut those that are proving unprofitable.”
Keen to retain workers, Japanese companies agreed to an average 5.1% wage hike in 2024, the biggest increase in three decades, a union survey showed.
In his speech on Thursday, BOJ board member Tamura said labour shortages were forcing hotels to reduce occupancy rates and meant some taxi operators had more cars than drivers.
As central banks have no power to address supply constraints, their mandate remains squarely on combating subsequent inflationary pressure by raising interest rates.
With stubbornly high raw material costs and labour shortages keeping inflation above the BOJ’s target for nearly three years, markets are now re-assessing their view rates won’t rise too much.
Governor Kazuo Ueda said last month the BOJ’s policy rate was still distant from levels deemed neutral to the economy, leaving scope for several more rate increases.
BOJ staff estimates Japan’s nominal neutral rate to be in a range of 1.0% to 2.5%. Having seen Japan’s prolonged struggle with deflation, many analysts had bet the highest the BOJ could hike would be up to 1%. But building inflationary pressures may reduce the chance the BOJ will pause there.
Growing market expectations that the BOJ’s terminal rate could be higher have helped lift Japanese government bond yields to multi-year highs and propped up the yen.
“There’s no reason why markets should assume that rates won’t rise beyond 1.0%, which is the bottom of the estimated range,” said a source familiar with the bank’s thinking.
（Addition reporting by Makiko Yamazaki)
