5.26%! Japan sees the largest salary increase in 35 years, central bank may open rate hike window ahead of schedule

Japanese companies are preparing for the biggest wage increase in 35 years, providing support for further rate hikes by the Bank of Japan. However, energy price shocks triggered by Middle East conflicts are disrupting this outlook.

On March 23, The Wall Street Journal reported that preliminary data released by Japan's largest labor organization, "Rengo," showed its 1,100 member organizations received an average wage increase of 5.26% this year, slightly higher than last year's 5.25%. Major companies such as Toyota, Honda, and Hitachi have fully met the unions' demands for wage increases.

This outcome has heightened market expectations for rate hikes by the Bank of Japan. Overnight index swap markets indicate that investors see about a 60% chance of a rate hike as early as April; S&P Global Market Intelligence economist Harumi Taguchi expects the Bank of Japan will raise rates to 1% in July. However, surging energy prices caused by escalating Middle East conflicts threaten both corporate profit margins and consumer demand, testing the virtuous cycle of wages and inflation.

Wage increases reach highest level since 1991

Rengo's data shows this year's "shunto" spring wage negotiations brought an average increase of 5.26%, marking the highest level since 1991. Rengo chair Tomoko Yoshino stated that this result reflects a consensus between labor and management on the importance of "investing in people," believing this move will help drive sustainable corporate growth and overall productivity improvements in Japan.

Large companies like Toyota, Honda, and Hitachi have fully accepted union wage demands, highlighting strong willingness to raise wages among big firms. Bank of Japan Governor Kazuo Ueda said the pay raise trend is extending to small and medium-sized enterprises. The regional branch manager meeting scheduled for early April is expected to provide more information on wage developments.

Middle East conflict impacts Japanese industries: Naphtha shortage, auto exports under pressure

Despite positive wage data, the impact of the Middle East situation on Japan's economy is becoming apparent. Marcel Thieliant, head of Asia-Pacific at Capital Economics, pointed out that about 70% of Japan’s naphtha (a key raw material for plastics production) comes from the Middle East and current inventories can last only about 20 days. Half of Japan’s refineries dependent on naphtha for plastics production have already cut output.

Exports are also under pressure. The Middle East accounts for 15% of Japan’s automotive exports, and manufacturers are facing difficulties delivering to the region. In addition, Moody’s Analytics economist Stefan Angrick highlighted that U.S. tariffs and intensified external competition pose extra risks.

The central bank maintains a rate hike stance, watches the situation evolve

The Bank of Japan kept its policy rate at 0.75% unchanged at last week’s monetary policy meeting, citing the need for more time to assess the economic impact of geopolitical conflict, but also stressed that domestic economic fundamentals remain solid before risk escalation, and it maintains its stance on seeking further rate hikes.

The Middle East conflict presents a dual challenge for the Bank of Japan. If commodity price shocks result in cost-push inflation, consumer demand will suffer; if corporate profit margins are squeezed, companies may be less willing to raise wages, undermining the virtuous cycle of wages and prices the Bank is working to build.

S&P Global Market Intelligence economist Harumi Taguchi stated: "If this trend continues among small and medium-sized enterprises and the Middle East situation stabilizes, this will be seen as evidence that the virtuous cycle of cost pass-through and wage increases can be sustained."

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