Japan’s nominal wages rose by 3% again, marking the longest continuous increase since 1992.

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Japan’s macroeconomy is showing a pronounced structural split. Nominal wages have marked the longest streak of consecutive increases in thirty years, yet this has not effectively translated into consumption momentum. Weak domestic demand and the survival predicament of small and medium-sized enterprises (SMEs) are intertwined, sketching a complex picture of the economic recovery process.

On Tuesday, Japan’s latest data showed that in May, nominal wages rose 3.2% year-on-year, and real wages increased by 1.4%, both maintaining strong growth. However, household spending decreased by 0.4% year-on-year, falling for the sixth consecutive month, highlighting the deep contradiction that wage growth has not offset the erosion of inflation and the insufficiency of consumer confidence.

Despite weak performance on the consumption side, the underlying logic of rising wages remains solid. The market has not only failed to scale back its bets on the Bank of Japan tightening policy, but has actually pushed the probability of an interest rate hike before December up to 88%, pricing in that the central bank will continue to move forward on monetary normalization.

The “wage-consumption” divergence, coupled with the wave of SME bankruptcies, not only tests the endogenous resilience of Japan’s economy but also provides a key data anchor for the Bank of Japan’s policy decisions amid a complex internal and external environment.

Structural Divergence between Wages and Consumption

In May, Japan’s nominal wages rose 3.2% year-on-year (April data revised up to 3.6%), slightly below economists’ expectations, but marking the first time since 1992 that year-on-year growth exceeded 3% for four consecutive months. After adjusting for inflation, real wages increased by 1.4%, representing the fifth straight month of growth.

This data continues the strong momentum of this year’s wage negotiations, with members of Japan’s largest union confederation receiving over 5% wage increases for the third consecutive year—the first since 1989 to 1991.

However, the nominal prosperity in wages has not translated into substantial consumption expansion. In May, household spending fell 0.4% year-on-year, shrinking for the sixth straight month. The root cause of this divergence lies in the fact that despite rising nominal wages, continued cost-of-living pressures are still eroding residents’ real purchasing power. When facing uncertainty, consumers tend to increase savings rather than spending, leading to a persistent limitation in domestic demand recovery momentum.

Labor Shortages Biting Back at SMEs

While large firms retain talent through wage hikes, SMEs are facing a severe survival test. In the first half of this year, the number of companies going bankrupt in Japan due to labor shortages reached 237, a record high.

This data reflects the enormous pressure that a severely tight labor market exerts on microeconomic entities. Under the dual squeeze of rising labor costs and hiring difficulties, SMEs that lack pricing power and cost-passing ability are hit first.

The rising number of business failures not only drags down the overall pace of economic recovery but also exposes the growing pains Japan’s economy faces in a period of structural transformation. If a large number of SMEs withdraw from the market, it will further weaken economic vitality and eventually bite back at long-term wage growth.

Bank of Japan May Raise Rates Further

Despite the headwinds of weak domestic demand and SME difficulties, expectations for continued rate hikes by the Bank of Japan during the year are growing stronger. The market currently prices an 88% probability of another rate increase before December, in part because sustained strong wage data reinforces confidence in a favorable “wage-price” cycle.

According to SMBC Nikko Securities economist Naoto Sekiguchi, as crude oil prices stabilize, as long as current wage levels are maintained, real wages will continue to grow positively, so the Bank of Japan is expected to stick to its rate hike path. Taro Kimura also believes that employers’ continued wage hikes to maintain competitiveness amid a tight labor market give the central bank sufficient reason to scale back stimulus.

However, the central bank’s decisions are not without constraints. At the April policy meeting, there were already clear divisions within the committee over whether to raise rates sooner. BOJ Governor Kazuo Ueda’s recent statements have also turned cautious, emphasizing the need to closely monitor the economic and price impact of developments in the Middle East and rising oil prices. Amid the tug-of-war between the underlying support from wage increases and the risks from external geopolitics and structural domestic demand imbalances, the Bank of Japan’s path toward policy normalization must still proceed with caution based on further data validation.

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