Japan economic outlook, July 2025

Wage growth disappoints despite solid announcements

Similar to last year, wage growth announcements at this year’s shunto (wage negotiations held in spring between employers and unions) were quite strong. For example, the Japanese Trade Union Confederation, also known as RENGO, announced an average 5.3% headline wage increase this year, up slightly from the 5.1% announced last year.⁵ Both figures are the highest Japan has seen since the 1990s. This fueled speculation that consumer spending would strengthen this year, ushering in a cycle of stronger underlying inflation and higher wage growth.

Despite the announcements of such strong wage increases, total wage growth in Japan remains relatively weak. Total gross earnings were up just 1% from a year earlier in May.⁶ In inflation-adjusted terms, gross earnings were down 2.9% over the same period. Some of the benefits of the wage announcements may not be showing up in the data just yet. Wage growth accelerated throughout last year, so stronger wage gains may still be coming this year. For example, in 2024, total gross earnings were up 4.4% in May but accelerated to 7.8% by December.⁷

Even if wage growth accelerates for the rest of 2025, it is unlikely to reach the heights seen last year. Scheduled earnings, which exclude overtime and bonuses, were up 2.1% on a year-ago basis in May. Although that is tied with the strongest growth rate posted so far this year, it is well below the 4.3% growth seen in May 2024. It is important to note that these wages are reported for the entire month, rather than per hour. After adjusting for hours worked, wage growth has held up much better. For example, per-hour scheduled earnings were up 4.1% from a year earlier in May, slightly higher than the 1.7% in May 2024.⁸

This means that the number of hours worked, rather than per-hour compensation, has held down aggregate income growth. Indeed, the number of hours worked per month has been extraordinarily low this year, with the average for the first five months hitting its lowest since the data series began in 1990.⁹ Although we cannot rule out the possibility that recent events such as trade tensions and high input costs are to blame, we suspect something else is contributing to this fall in hours worked.

There has been a more structural decline of working hours over the last 35 years, with the average number of monthly hours worked declining from 172 in 1990 to just 136.9 in 2024 (figure 1).¹⁰ The government has also encouraged businesses to move toward a four-day work week, though take up seems to be relatively muted so far.¹¹

The persistence of inflation

Headline inflation decelerated to 3.5% year over year in May 2025, down from 4% in January.¹³ Much of this deceleration comes from food and beverages even though rice prices continued to surge. For example, year on year, rice inflation accelerated from 70.9% in January to 101.7% in May. Meanwhile, total food and beverage inflation slipped from 7.8% to 6.5% over the same period.¹⁴ Education prices also dropped considerably, thanks in part to government subsidies in Tokyo.¹⁵

Energy, food, and beverages have been some of the strongest drivers of headline inflation. However, other subcomponents of inflation have looked more benign. For example, western core inflation, which excludes food, beverages, and fuel costs, softened to 1.5% on a year-ago basis, down from 1.6% the previous month. Month to month, western core prices were flat in May.¹⁶

Some components of inflation are expected to ease this year. Rice prices fell for three consecutive weeks ending June 8, which should take at least some of the pressure off inflation.¹⁷ The declines have been relatively modest so far, but prices are now moving in the right direction. A stronger yen is also expected to ease import prices and limit the rebound in energy-related inflation that could come from the recent rise in crude-oil prices globally. Real consumer spending has been relatively muted, while real wages are falling, which will make it more challenging for businesses to raise prices in the near term.

Below-target western core inflation and an anticipated slowdown due to a changing global trade landscape suggest that monetary policy will remain on hold for at least the rest of this year. Indeed, the Bank of Japan expects that inflation will ease to just 2% in the fiscal year ending March 2026, down from the 2.2% previously forecasted.

The central bank’s outlook for GDP has come down even more substantially to 0.5% from a previously forecasted 1.1%.¹⁸ The Bank of Japan is also expected to slow the pace of its cuts to government-bond purchases early next year in an effort to allow for additional support to the economy.¹⁹

There is still a nontrivial chance that the central bank will have to tighten policy sooner than anticipated. For one, a favorable trade agreement would likely pull forward the timing of the next rate hike. There is also evidence that services inflation is beginning to accelerate. Falling food prices could fuel more demand for such services and drive prices higher. At the same time, all three of the Bank of Japan’s underlying inflation measures (trimmed mean, median, and mode) have accelerated through April—though median and modal inflation are still below the 2% threshold.²⁰ Inflation expectations also continue to move higher, which could force monetary policymakers to adopt a more hawkish position to prevent expectations from turning into reality.²¹

Global trade headwinds are still blowing

One of the most uncertain aspects of this outlook revolves around international trade. As of this writing, Japan had yet to reach a trade agreement with the United States.²² Without a trade deal, most Japanese exports to the United States face a 10% tariff, while auto exports are hit with a 25% tariff. Tariffs could move even higher if a deal is not reached soon. This is particularly worrying for Japan as goods exports accounted for roughly 17% of GDP last year.²³ The comparative figure in the United States was closer to 7%.²⁴ To make matters worse, the United States was the largest destination for Japanese goods exports in 2024, with exports worth more than 21 trillion yen.

Evidence of a slowdown in trade is already showing up in the data. Japanese goods exports had surged in the first quarter of 2025 ahead of tariffs, but had fallen by 1.7% in May on a year-over-year basis.²⁵ Unsurprisingly, goods exports to the United States were notably weak, falling 11.1% over the same period (figure 2). Motor vehicle exports to the United States were among the most adversely affected, falling 24.7% from a year earlier in May.

However, most major goods exports to the United States, including chemicals and electrical machinery, were also down on a year-over-year basis in May.²⁶