Will consumption rebound? 

Stronger domestic consumer spending is likely a requirement for Japan to sustain its inflation target and keep output growing. The good news is that consumer fundamentals have improved. Nonagricultural employment was up 1.1% from a year earlier in December.⁴ Meanwhile, contractual wages were up 2.5% over the same period—the strongest pace of growth since 1994.⁵ As a result, the real consumption activity index, after adjusting for travel, posted its second consecutive nonnegative year-over-year growth rate.⁶ Consumer spending is expected to pick up this year, assuming the next budget includes the promised tax breaks and energy subsidies.⁷

The main impediment to stronger domestic consumer spending is inflation. Even with such strong contractual wage growth, headline inflation was even higher, at 3.6% year on year in December.⁸ Energy and fresh food prices have been rising quickly. Energy prices were up 10.1% from a year earlier in December, while fresh food prices were up 17.3%.⁹

For consumer spending to rebound, wage growth needs to outpace consumer inflation. Fortunately, total cash earnings, which include bonus payments, grew faster than inflation in December. In addition, wage growth is expected to remain relatively strong. Early indications of this year’s shunto—the annual wage negotiations for Japan’s unions—show signs of another year of solid wage growth. For example, a major union, Rengo, is asking for a pay rise of 5% or more.¹⁰ Last year’s shunto ultimately yielded a 5.1% wage increase.¹¹

Inflation is also expected to move lower. Western core inflation, which excludes food and energy, was just 1.6% year over year—about where it has been for six months (figure 1).¹² This suggests that underlying inflation remains relatively benign. However, getting food and energy prices under better control will be imperative to revive domestic demand. Japan is expected to release some of its emergency rice stockpiles to limit food inflation,¹³ but policymakers only have so much control over commodity prices. Given that these are globally traded commodities, events in other parts of the world, such as supply disruptions, can have outsized effects on their prices.