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Real Wages Drop Again: BOJ Caught in a Tight Spot

Japan’s economic recovery is facing fresh turbulence as real wages continue to slide and global trade tensions mount. In May, inflation-adjusted wages fell 2.9% year-over-year, the steepest decline in 20 months, according to data released by Japan’s Ministry of Health, Labour and Welfare. That follows a revised 2% drop in April, making May the fifth consecutive month of decline in real wages.

The trend is especially concerning given that this year’s spring wage negotiations yielded the biggest nominal salary increases in more than three decades. Japan’s largest labor union, Rengo, reported that its members secured an average pay hike of 5.25%—the most since 1991. Yet with inflation running at 3.5%, the gains are being wiped out in real terms.

While nominal wages have climbed every month since December 2021, real wages have decreased in more than 30 of the last 41 months. This persistent erosion of purchasing power is undermining household consumption and putting added pressure on the Bank of Japan (BOJ) as it considers its next policy move.

Inflation, Trade Pressure, and Shrinking Growth

At the same time, Japan’s economic growth is slowing. In the first quarter of 2025, GDP contracted 0.2% from the previous quarter—marking the first decline in a year. The contraction was largely driven by a slump in exports, which form the backbone of Japan’s trade-dependent economy.

Now, the situation is set to worsen as the U.S. prepares to implement 25% tariffs on Japanese imports beginning August 1. These steep tariffs could deliver another blow to Japan’s already fragile export sector, reducing external demand just as domestic consumption is faltering under the weight of declining real wages.

Inflation in Japan has remained above the BOJ’s 2% target for over three years. While the central bank has long maintained that a "virtuous cycle" of rising wages and prices would justify lifting interest rates, the current economic climate complicates that goal. Instead of a balanced cycle, the country is experiencing inflation outpacing income growth—effectively weakening consumer spending and undercutting any gains from salary hikes.

Divided Views on BOJ’s Next Move

The BOJ is at a crossroads. Should it raise rates to counter inflation, or maintain its ultra-loose monetary stance to prevent deeper economic slowdown?

Analysts remain divided.

Hirofumi Suzuki, Chief FX Strategist at Sumitomo Mitsui Banking Corporation, told CNBC that while May’s wage decline might be temporary, the broader struggle for real wage growth suggests limited momentum for consumption. This, in turn, casts doubt on the strength of the BOJ’s so-called “virtuous cycle.”

Jesper Koll, expert director at Monex Group in Tokyo, offered a different view. He believes that rising inflation ahead of wage growth may actually justify rate hikes. A stronger policy rate, he argues, could help strengthen the yen—improving purchasing power and reducing the cost of imports. Given that roughly one-third of Japan’s Consumer Price Index is influenced by imported goods, currency strength plays a critical role in taming inflation.

Meanwhile, Vishnu Varathan, Managing Director at Mizuho Securities, suggested a more cautious approach. He believes the BOJ should hold off on any moves, citing the risk that tightening policy could choke domestic demand just when it’s needed most. “The optimal game-plan for the BOJ may be to do nothing,” Varathan stated, arguing that the central bank should “affirm the tightening bias” without committing to immediate hikes.

Governor Ueda’s Outlook

Despite growing challenges, BOJ Governor Kazuo Ueda remains cautiously optimistic. Speaking last month, he emphasized that Japan’s economy is resilient enough to absorb external shocks, including the impact of U.S. tariffs. He also reaffirmed his belief that the cycle of rising wages and prices will continue, albeit at a slower pace.

Yet with inflation stubbornly high, real incomes shrinking, and growth faltering, Ueda’s optimism will soon be tested. The coming months will be critical in determining whether Japan’s central bank can navigate this complex environment without triggering deeper economic distress.

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Japan is entering a pivotal phase in its post-pandemic economic trajectory. The combination of sluggish real wage growth, persistent inflation, and looming trade barriers presents a unique set of challenges for policymakers. As the Bank of Japan weighs its next steps, it must carefully balance the urgency of price stability with the risk of stalling the broader recovery. All eyes are now on Tokyo—and the BOJ’s next move could shape Japan’s economic landscape for years to come.

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