BOJ Governor Sees Tight Labor Market, but Wage Stagnation and Low Productivity Weigh on Rate Normalization

Expectations rise for rate hikes amid wage growth outlook
Inflation outpaces wage gains, eroding real incomes
Structural reforms seen as prerequisite for policy shift

Kazuo Ueda, governor of the Bank of Japan, has offered an optimistic assessment that wage growth will accelerate as labor market tightness spreads. That has fueled market speculation over the prospect of rate hikes in the near future. Yet with Japan’s long spell of low growth and ultra-low interest rates, the structural reality of inflation outpacing wages remains, raising doubts over whether rate normalization is possible without addressing underlying issues such as weak productivity.

Hints of a rate hike cycle resumption

Speaking at the Federal Reserve’s annual symposium in Jackson Hole, Wyoming, on the 23rd, Ueda noted that “wage growth trends are spreading from large firms to smaller companies,” adding that “barring any major demand shocks, the labor market will remain tight and continue to exert upward pressure on wages.” Markets have interpreted the remarks as a sign that the rate hike cycle—halted amid concerns about the impact of U.S. tariffs and other external shocks—may soon resume.

The signal is significant given Japan’s long stagnation since the collapse of its asset bubble in the 1990s. The Bank of Japan has long struggled to justify rate hikes in the face of weak growth and inflation undershooting its 2 percent target, which entrenched ultra-low rates and quantitative easing as permanent fixtures of monetary policy. Now, with inflation consistently above target and labor conditions tight, pressure is mounting for normalization. Labor shortages and stronger wage bargaining are seen as forces that could sustain price increases, creating a potential opening for policy shifts.

Markets are closely watching whether a policy turn at the BOJ could mark a broader turning point for the economy. For recovery to hold, prices and wages must move in tandem in a virtuous cycle; only then would higher rates be sustainable. If wage growth materializes, the BOJ could exit its ultra-low-rate stance and restore policy flexibility. But if wages fail to keep pace, premature hikes risk undermining recovery. This uncertainty underscores why the timing of a rate move remains difficult to predict.

Erosion of consumer purchasing power

For now, the slide in real wages remains a major obstacle. In May, real wages fell 2.9 percent year-on-year—the steepest drop in two years—despite a 1.0 percent rise in nominal wages, as price increases far outstripped pay. That leaves the BOJ with weakened momentum for pursuing policy tightening.

The decline reflects deep-seated problems. Since the pandemic, inflation has exceeded the 2 percent target, but companies, citing higher costs, have been reluctant to raise wages. With pay stagnant, households’ purchasing power has continued to erode. A rate hike under such conditions would only add to debt servicing burdens and further squeeze consumption. Policymakers thus face the twin challenge of managing inflation while breaking wage stagnation.

This is why the BOJ must tread carefully on normalization. Hiking rates solely on the basis of higher prices risks a broad social backlash, and without wage gains, the legitimacy of such a move would be hard to defend. Ultimately, the trajectory of real wages will determine monetary policy, and without a rebound, rate normalization will remain constrained. The issue also intersects with broader structural challenges facing the Japanese economy, ensuring it will remain a central variable in policy debates.

Productivity reform seen as key to sustained recovery

At the root of Japan’s malaise lies chronically weak productivity. Rigid seniority-based employment practices and lifetime job security weaken the link between responsibility and reward, while discouraging talent mobility. A multilayered subcontracting structure, reliance on paperwork and in-person meetings, and a pervasive risk-aversion culture all slow the pace of change and experimentation.

The stagnation of real wages is closely tied to this low productivity. Middle management’s tendency to avoid risk and responsibility has slowed adoption of new technologies, while compliance-focused management has reduced scope for experimentation and learning. Costs are easily cut under such systems, but redesigning work processes is often delayed. Over time, this inevitably drags down output per hour.

The numbers are telling. According to the Nikkei, between 2019 and 2022, labor productivity in Japan’s IT sector fell 13 percent—the sharpest decline among G7 nations, and the only double-digit drop. Over the same period, the U.S. and U.K. posted gains of 27 percent and 9 percent, respectively. The Nikkei attributed Japan’s decline to inertia in development methods, reliance on legacy systems, and siloed data across departments. Weak connections between IT investment and output have worsened the productivity slump.

Experts broadly agree that without structural reform, wage-led recovery will remain elusive. Unless labor markets are liberalized, rigid corporate practices loosened, and technology investment expanded, Japan’s low-wage, low-productivity equilibrium will persist. That would not only suppress real wage growth but also limit the BOJ’s ability to pursue normalization. Productivity reform, they argue, is the only path to ending Japan’s long stagnation and enabling a genuine shift in monetary policy.