Capex, wages key to inflationary mindset taking hold among households

In yet another indication that inflation is gaining a firm foothold in Japan, the core consumer price index (CPI) excluding fresh food items rose 2.6% year-on-year in March. This keeps it above the Bank of Japan (BOJ)’s 2% target for the second consecutive year. However, to gauge whether an inflationary mindset is becoming entrenched among households, the influence of capital expenditure (capex) and wages on spending behaviour may provide a more accurate insight.

Following the annual “shunto” wage negotiations between employers and Japan’s biggest labour union, Rengo, the average base salary is projected to rise by 3.57% this year. This marks the highest increase in over three decades. The rise is significant in two ways. Firstly, the substantial wage hikes to be granted by companies are backed by increasing sales and profits. When the deflationary mindset was still prevalent, companies tended to limit capex, set a cap on wages due to an excess of labour and reduce production. However, companies are now taking a more aggressive approach. They are finding it more beneficial to invest in capex and increase production, and amid the current labour shortage, to increase wages to retain and attract talent.

One reason why the CPI may not reliably indicate the establishment of an inflationary mindset among households is its exclusion of wage data. If wage growth cannot keep up with inflation, households may find it difficult to shake off a deflationary mentality. However, the significant rise in base salaries following the shunto negotiations suggests that growth in wages could eventually surpass inflation. This condition—a real rise in wages—will allow an inflationary mindset to take hold as it will enable income to keep up with expenditure.

Depreciation in the yen, which recently fell to a 34-year low versus the dollar, could undermine the transition to an inflationary mindset even if wages rise in real terms. This is because a weak currency, which inflates import costs, tends to impact the more visual aspects of consumption, such as spending on energy and food. There are encouraging signs, however, as energy costs have been declining while the rise in food prices appears to be decelerating.

Despite recent adjustments, Japan stocks seen maintaining their uptrend

The surge in Japanese stocks that took the Nikkei Stock Average to a record high above 40,000 has slowed, and the index has been hovering near 38,000 for the past month. Despite this slowdown, the stock market, in our view, is still in the midst of a long-term uptrend, and our forecast for the Nikkei to reach 45,000 at the end of the current fiscal year in March 2025 remains unchanged.

We maintain our forecast for two reasons. Firstly, the Middle East tensions that emerged in April, causing a decline in Japanese stocks, may not be having such a detrimental impact on oil prices as initially feared. Oil prices have in fact declined since tensions between Israel and Iran escalated in April. While developments between the two countries continue to be watched closely, the market has had an opportunity to observe that actual oil-producing nations were relatively unaffected by this recent surge in geopolitical tensions.

Secondly, the market was ready to take a breather after the sharp rally in March, and adjustments were necessary. The Nikkei’s pullback from record highs was closely correlated with a drop in the Philadelphia Semiconductor Index, or SOX, during the same period. Semiconductor-related companies were instrumental in the Nikkei’s record-breaking rally. Although their recently released results were generally positive, even a slight expression of concern about future earnings from some companies seemed to momentarily dampen sentiment towards the sector. Expectations for semiconductors appeared to have outpaced reality. Adjustments were due, though the sector is seen continuing to benefit from AI-driven demand in the long term.

Looking ahead, Japanese stocks could benefit from the market’s focus shifting away from the weak yen’s advantages and growing interest in sectors beyond semiconductors. The weak yen’s impact on the gains seen in Japanese stocks is indisputable, with exporters being the primary beneficiaries. However, other sectors with growth potential, such as travel and hospitality, banking, retail sales and real estate, could benefit from actual economic expansion. These sectors still have room for more growth as Japan continues to transition into an inflationary economy. Moreover, these sectors will be relatively immune to the yen’s fluctuations at a time when the BOJ’s monetary policy could trigger currency volatility. Even if the yen appreciates over time, Japan still possesses numerous potential growth narratives supported by fundamentals.

Japan equities slip in April as geopolitical tensions cast shadow over the market

The Japanese equity market ended April lower with the TOPIX (w/dividends) down 0.91% on-month and the Nikkei 225 (w/dividends) falling 4.86%. The BOJ left its monetary policy unchanged at its April Monetary Policy Meeting, supporting Japanese equities, but the market was negatively impacted by investors’ growing risk-off sentiment amid escalating tensions in the Middle East as well as the decline in the US equities market as the outlook faded for the Fed to cut rates at an early stage, given the announcement of strong economic indicators in the US. Semiconductor-related stocks also weighed down the Japanese market after a major Taiwanese contract semiconductor manufacturer scaled back its outlook for chip market growth. Another negative factor was disappointing earnings results released by certain major firms both in Japan and abroad.

Of the 33 Tokyo Stock Exchange sectors, 13 sectors rose, with Marine Transportation, Nonferrous Metals, and Wholesale Trade posting the strongest gains. In contrast, 20 sectors declined, including Pulp & Paper, Retail Trade and Air Transportation.

Exhibit 1: Major indices

Source: Bloomberg, 30 April 2024

Exhibit 2: Valuation and indicators

Source: Bloomberg, 30 April 2024