In March 2024, the Bank of Japan (BOJ) ended its years-long experiment with negative interest rates to try and stem the country’s economic stagflation. This decision came after Rengo, Japan’s largest labor union, negotiated a deal that saw some of the countries’ largest companies – including Honda, Nippon Steel, and ANA Holdings – provide their workers with a 5.28 percent wage hike, the highest in 33 years. While speculation of the move initially gave economists hope that “the changes may also see some investors consider repatriating funds to Japan […] as interest rates could coax more investors towards JGBs [Japanese government bonds] over foreign bonds,” this hope may have been premature and ignored a few domestic and foreign factors that could have an inhibiting impact on this policy shift.
On the domestic side, speculation by economists that the increase to a 0.1 percent interest rate could see a change in Japan’s investment habits has largely ignored the country’s engrained saving culture. Oxford Economics’ senior economist Norihiro Yamaguchi stated that “stubborn inflation and pay rises failing to keep up with price rises […] have begun to change this [saving culture] […] maintaining savings in the form of cash or checking account would make little sense as the real value of them would shrink.” However, data on this trend provides a mixed view on whether the country’s saving culture and financial risk-taking are really changing.
Prior to the March wage hike, Japan was experiencing what many economists consider “bad inflation,” meaning that the weaker yen was hiking the price of everyday goods such as food or fuel. While older Japanese investors appear to be wary of this trend due to their experience with the Nikkei stock market crash in the 1990s, younger investors appear to be more risk-resilient. According to surveys conducted by the Investment Trusts Association, 23 percent and 29 percent of Japanese in their 20s and 30s, respectively, invested in a mutual fund in 2023. Nevertheless, the latest BOJ quarterly survey found that households still have approximately $7 trillion in cash and savings, far outmatching the total investment assets held by households.
While the BOJ likely hopes that the recent wage hike could further spark an investment boom amongst the younger Japanese generation, the unequal nature of the recent wage increases could lower the likelihood of this occurring. The deal negotiated by Rengo was on behalf of its nearly 7 million unionized workers and largely does not apply to those who work for the small- and medium-sized enterprises (SMEs) that account for 70 percent of Japan’s national employment. Therefore, although a large proportion of the Japanese population is unlikely to reap the benefits of this historic deal, they are, nevertheless, still faced with having to confront the broader impacts of the interest rate hike. Most importantly, companies will be faced with having to pay a lot of money to borrow for the first time in decades, which could stifle their investment in new technology, high-cost projects, and research and development.
According to a 2024 Reuters survey, around 60 percent of Japanese firms expect interest rates to increase further to 0.25 percent by the end of 2024. As such, the survey participants are looking to finish their project spending early in the year before borrowing costs increase further. However, some firms – such as a Tokyo-based water treatment equipment design firm quoted in Asahi Shimbun – have shelved larger-scale projects due to concerns about borrowing costs. These concerns increase the risk of SMEs being unable to grow their businesses sustainably as these additional costs cut into their razor-thin profit margins and lower the likelihood of them also giving their employees a similar 5.28 percent wage increase. This scenario could further the trend of households hoarding cash and result in companies cutting costs, including layoffs, to bridge the perceived upcoming economic hardships.
Meanwhile, the ongoing decline of China’s economy also presents a potential risk to the success of Japan’s monetary policy shift. China is Japan’s largest trading partner and accounts for 20 percent of its exports. However, China is experiencing a weaker-than-expected economic recovery from the COVID-19 pandemic fueled by its shrinking middle class, the bursting of its property bubble, and the subsequent decline in domestic consumer spending. This overall decline in economic output could also see Sino-Japanese trade fall throughout 2024, negatively impacting both large and SME companies in Japan. While the Japanese yen’s fall to near-recorded lows following the BOJ’s interest rate hike could prove beneficial for Japanese exporters seeking to cheaply sell their products abroad, a weak yen could also negatively impact domestic businesses and households with increased import costs.
In line with this, the Japanese service sector will likely be the most adversely impacted by the aforementioned factors. Japan’s service sector – which includes tourism – accounts for 70 percent of the country’s GDP. The total number of inbound tourists to Japan in 2023 reached 25 million people and brought in a record $35.9 billion. However, the total number of inbound from China – which constituted the largest group and biggest spenders before the COVID-19 pandemic – has not returned to pre-COVID levels despite how weak the yen was over the last year. While sentiment amongst service sector firms is largely positive as they continue to recover from the pandemic, the sector will likely continue to be held back at least partially by China’s domestic economic woes and the suppressing impact it has had on the demand amongst Chinese households to engage in costly outbound tourism.
These depressing economic factors are unlikely to abate – especially China’s economic struggles – in the coming year. As such, there is a heightened risk of the impacts of Japan’s monetary policy shift – namely increased cost of borrowing, increased costs of goods, increased price of imports, and so on – having a negative impact on Japan’s critical service sector, especially as its largest customer base is struggling to spend as much as in prior history. Such a scenario could result in service sector SMEs further cutting costs throughout the year to protect their profit margin, especially as the increasingly weakening yen burdens them with growing import costs of business-critical supplies.