News In Charts: Japan – Spring Wage Negotiations Key As Boj Shifts To A ‘Neutral’ Stance

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The further improvement in headline earnings growth in Japan, which reached 0.8% in the twelve months to December, was of course welcome news. Nevertheless, CPI inflation continues to outstrip wage increases so that real wage growth remains firmly in negative territory. Moreover, the headline earnings figures mask more subdued increases in basic pay, with contractual labour cash earnings rising by 0.2% over the same twelve-month period. It is the more flexible components of remuneration – such as overtime pay (up 4.6%) and bonus pay (up 1.4%) – that have boosted headline earnings growth.

This year’s shunto spring wage negotiations are key. Will the increase in the more flexible components of pay captured by “wage drift” – the difference between total pay growth, and growth in contractual pay – feed through to bigger rises in contractual pay? There are some grounds for optimism. First, corporate profitability received a sizeable boost in 2013, courtesy of the first wave of Abenomics. Second, the economy’s cyclical momentum has been strong of late; January’s Manufacturing PMI rose to 56.6, the highest in almost eight years, while the Shoko Chukin small firm sentiment index also edged up to multi-year highs, confirming the positive message from the latest Tankan survey. Third, the employment market has been showing signs of firming recently; the jobless rate fell by 0.3 percentage points to 3.7% in December and the ratio of available jobs to applicants improved to 1.03 – the highest since October 2007.

However, any optimism should be qualified at this stage. The weakness in core wages is in part a consequence of a sustained increase in the number of part-time relative to full-time workers, with the former commanding lower salaries. Moreover, the decision of Japanese corporates regarding potential increases in base pay is likely to depend on more than current labour market dynamics. Perhaps more importantly, their reluctance can be taken as a reflection of limited confidence in the ultimate success of Mr Abe’s policy experiment – a reminder that dispelling the entrenched deflationary mentality in Japan is going to take time and effort. There may also be a political element at play, in view of Mr Abe’s stated intention to revamp the corporate tax system: large firms may have an incentive to delay base pay increases as part of their negotiation tactics.

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Against this backdrop, real wages remain under pressure. The weak yen policy that still forms the bedrock of Abenomics has been successful in fuelling higher, yet predominantly cost-push, inflationary pressures. Annual headline inflation has gone some quite way, moving from a negative 0.7% annual rate at the time of QQE’s launch to +1.6% eight months later, but the trend in import prices – up 17.6% in the twelve months to December – continues to hurt real household incomes. The mirror image of higher CPI has been lower real wage growth – real wages fell by 1.1% in the twelve months to December, denting consumer confidence. And of course we are yet to see the impact of April’s VAT increase, which could boost CPI inflation by some two percentage points.

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This contrast between pockets of positive momentum in the Japanese economy with a persistently problematic labour income picture may also lie behind what, in our view, is evidence of an implicitly “middle of the road” attitude adopted by the Bank of Japan at its last policy meeting. According to the accompanying statement, the annual rate of CPI “is likely to be around 1.25% for some time”, which Mr Kuroda later clarified as being around six months. This marks a subtle – yet potentially significant – departure from the view expressed in December’s meeting that the “rate of increase in CPI was likely to keep rising…for the time being”. Our interpretation of this change in stance is two-fold.

First, while the Bank seems to be gaining confidence that it can achieve its ambitious inflation target, this statement is perhaps an implicit acknowledgement that the first, “easy” gains in CPI – imparted by a sharp depreciation of the yen – are likely behind us. In other words, Mr Kuroda’s task is only going to get tougher going forward. Second, a step-up in the pace of monetary easing does not appear to be on the cards for now, as Mr Kuroda seems reluctant to act pre-emptively at this stage: “if upside or downside risks don’t materialize, we’ll continue with current policy”, he said after January’s policy meeting. While this is in line with a sense of optimism that the economy will be strong enough to withstand the upcoming VAT hike, we also suspect that the BoJ might not want to be seen as adding more fuel to “bad” inflation at this stage – at least not before the spring wage negotiations conclude.

As such, the BoJ is likely to refrain from expanding its asset purchase program unless the inflation trend deteriorates markedly from current levels or GDP growth fails to pick up in the coming quarters. Nevertheless, we think this is a matter of “when”, not “if”, particularly as Mr Abe’s “third arrow” keeps failing to land. At the same time, Mr Kuroda will not have lost sight of the fact that Japanese assets are in no way immune to gyrations in emerging markets, as our chart illustrates. We would not be surprised if the Bank opted to lean against bouts of extreme market volatility, even if only through verbal interventions.

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The baton needs to be passed from a depreciating currency to a convincing domestic recovery as the source of sustainable, virtuous inflationary impulses in Japan. And for this to occur, action on structural reforms is called for sooner rather than later. In Davos, Mr Abe said he is “willing to act like a drill bit, strong enough to break through the solid rock of vested interests”. Now is the time.
Elsewhere this week, there emerged signs that the ECB is considering bringing to an end the policy of sterilising, week after week, the outstanding stock of SMP purchases – currently valued at a little under €180 billion. This would be a first step on the road towards our expectation, set out in this column on the 17th of January , that the ECB will conduct unsterilised QE in order to fight off the threat of persistently low inflation.

According to news reports on Monday, senior ECB officials claimed that Mr Draghi was mulling the option of foregoing sterilisation for the remaining SMP holdings, if the Bundesbank could sell the move to the German public. Following the announcement of the SMP back in May 2010 the ECB clarified that it would re-absorb the extra liquidity by carrying out quick tenders in order to collect one-week fixed term deposits of equivalent value. The ECB on Tuesday went ahead and did precisely that for the full €175.5 billion – the book value of the Eurosystem SMP holdings; the Bundesbank won this round but there are many more to come. If Mr Draghi does eventually get his way, and given that the ECB has already stated that it will hold SMP purchases to maturity, the system will be left with a substantial amount of extra liquidity for many years. In our view, this effective cash injection is sorely needed. Excess liquidity – the difference between the sum of overnight deposits and current account holdings, and reserve requirements – has fallen further still and currently stands at €144bn, well below the €200 billion that Mr Draghi has cited as the minimum level required to prevent unwarranted rises in the EONIA rate.

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Early LTRO repayments mean that, as a proportion of the output of their respective currency areas, the balance sheet of the ECB might soon be smaller than that of the Fed for the first time. The ECB, in our view, has scope to do much more.

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