Japan 2025 Outlook: A slightly stronger economy and a stubbornly weak Yen should support moderate hikes by the Bank of Japan

In 2024, optimism on the Japanese economy ended up facing two major headwinds. The positive news began from strong results on the spring wage negotiation, which lifted nominal regular wages at the highest growth rate in three decades.While these developments should have allowed for private consumption to support the economic recovery, the optimism faded as higher inflation from imports, fed by the weakening Yen, harmed consumption but also created manufacturing bottlenecks. Furthermore, because households started to rebuild their savings, which had financed pent-up demand last year, private consumption remained subdued. On top of this, after a large earthquake disrupted the supply chain in January 2024, the suspension in auto production from testing scandals prevented the manufacturing sector to respond to external demand despite of the weak Yen.For 2025, these headwinds are expected to stabilize, helping the Japanese economy to bottom out. As auto production has normalized, manufacturing activities have picked up, removing the bottleneck to meet external demand.Furthermore, policy responses are anticipated to focus on measures to lift real wages. The JPY 21.9 tr fiscal stimulus package is expected to include energy subsidies in addition to measures to promote technology, which is estimated to lift GDP by about 1% (Chart 1). For the new fiscal year starting April 2025, households are likely to receive tax relieves, including adjustment of taxable income to inflation for the first time since 1995.On the other hand, the Bank of Japan (BoJ) is expected to normalize further by raising the policy rate by 50 bps in 2025. With increasing confidence on the virtuous circle between nominal wages and inflation, the BoJ is anticipated to hike by 25 bps in March 2025 when the results of the spring wage negotiation start to become available. Furthermore, as the Fed’s tone has become less dovish since Trump won the US Presidential elections and strong economic data was reported, the impact of Yen of a less dovish Fed has been evident.  In fact, the Yen has depreciated once again which would increase import prices (Chart 2).  Such a weak Yen is bound to further diminish Japanese households’ purchasing power, leading the BoJ to hike further once again by 25 bps in October 2025 when the Bank updates its economic outlook.All in all, supported by policy responses, the Japanese economy is expected to stabilize by +1.1% in 2025 from a low base of -0.2% in 2024 while the BoJ should increase rates by 50 basis points this year.