Yuko Iizuka, Economist at Asset Management One, writes that enthusiasm amongst overseas investors for Japanese equities has gone through a sea change as Japan finally emerged from a period of negative interest rates, slow economic growth and deflationary pressures.
With Japanese wages now also growing in real terms can wage inflation also add to the impetus behind the Japanese economy. How long will this trend continue? How high will Japanese wages go – or could underlying demographic challenges shorten this recovery in wages and consumer confidence?
If wage growth does feed through into higher consumer spending sectors of the economy, which are best placed to benefit from that?
Japanese real wage likely to continue growing for next few years
The Government is now actively supporting wage growth to avoid inflation eating away at household budgets – which would reduce consumption. Government assistance to help real wages is set to continue rising – surpassing price increases – over the next few years.
2024’s minimum wage increase rate of approximately 5 per cent is far higher than the norm for that past three decades. Meanwhile, growth in the Japanese Consumer Price Index (CPI) was 2.7 per cent in the year to August 2024.
The Government has set a target to further raise the minimum wage to 1,500 yen per hour by the mid-2030s. If this target is achieved, we should expect annual wage increases exceeding 3 per cent.
Most analysts initially assumed that inflationary pressures would not spill over into domestic prices – judging that companies would be unable to raise prices for fear of losing consumers. However, Government measures subsidising consumer prices and supporting wage increases have enabled companies to pass on price increases while stimulating above-inflation wage growth.
Service prices in Japan – directly influenced by wage trends – will likely rise in the short term. Real terms durable goods consumption has already recovered to pre-pandemic levels, while services expenditure has yet to reach pre-pandemic levels.
Retail and service sectors poised to benefit most
The retail and service sectors are likely to significantly benefit if wages continue to grow. Data from the past 20 years shows a strong positive correlation between wage growth and consumer spending – suggesting rising wages will increase household expenditure.
The age groups experiencing the fastest wage growth are workers in their 20s to early 30s – and the smaller purchasing power of the 60+ bracket.
While consumers in their 20s tend to spend more on rent, eating out, culture and recreation, expenditure for those aged 60+ skews more towards groceries, healthcare, and car and tech repairs. Given that Japan’s minimum retirement age is 60, consumption trends among those in their 20s will have a greater impact on the Japanese economy.
We expect that equities in these consumer subsectors will benefit from that considerable jump in demand. Over the past three months, the TOPIX industry indices show the retail sector has outperformed with an average share price rise of +8.5 per cent. Service sector shares have risen by +6.3 per cent on average – significantly outperforming the overall TOPIX, which declined by 3.1 per cent.
Market expectations of wage growth and price inflation have been major drivers of rising Japanese share prices over the past year.
Labour shortages and a weak yen contributing to real wage growth
Japan’s major demographic challenges – chiefly an aging population and declining birthrate – will further contribute to sustained wage increases. Both factors will exacerbate labour shortages in the long term. Current labour shortages are also prompting short term investments in automation – enhancing labour productivity and further supporting wage growth.
Additionally, the yen’s weakness against the dollar has now likely peaked. Wage growth is now being supported by a stronger yen – helping ensure sustainable wage growth for Japanese workers.
However long-term economic anxiety among Japan’s youth could incentivise greater saving – hampering further growth in the economy
While wage growth now outpaces inflation, it’s still only a modest increase – just over three per cent. Japan is already burdened by an expensive welfare state and growing welfare contributions will bite into this extra disposable income.
Longer-term anxiety – particularly amongst younger people – may constrain further increases in consumer spending. Japan’s long term economic prospects remain uncertain, particularly with an ageing and declining population – and corresponding ballooning welfare costs. Many younger people see greater saving as the prudent option for the long term.
There’s a large economic incentive for the Government to keep supporting wage growth – boosting domestic consumption. We, therefore, expect this trend of real terms wage growth to continue over the medium term. However, to secure sustainable wage growth in the long term, the Government will have to consider the structural changes needed to address a declining population.
Japanese households and Government are enjoying the short-term benefits of increased economic activity. Both want to realise the benefits of the current economic uplift – wages will keep growing, at least until the 1,500 yen per hour target is hit.
