James Ghusn
Japan’s ‘lost decades’ refer to the 30 years since the burst of its asset bubble in the early 1990s, where growth in the once ascendent economy faltered. Since then, inflation had mostly been a myth — but this is changing, representing a significant milestone while posing new challenges for Japan.
From 1993–2019, prices rose more than 75 per cent for urban consumers in the United States. In Japan, that figure was closer to 5 per cent. Fast forward to 2025 — Japan’s fourth consecutive year of inflation above its 2 per cent target. Macroeconomic settings in Japan are starting to look ‘normal’ compared to the rest of the developed world for the first time in decades. Steady nominal wage growth has provoked speculation that Japan has finally conquered chronic low inflation. But the slowdown in global trade and a sensitive bond market suggest that any resounding declarations may be premature.
In its June 2025 meeting, the Bank of Japan (BOJ) opted to maintain its policy rate at 0.5 per cent. Governor Kazuo Ueda indicated that ongoing downside risks from the global trade environment have dampened the BOJ’s appetite for further rate hikes in the near-term.
The BOJ’s response to elevated inflation has historically been cautious. In Japan, zero lower bound and negative interest rates were not extraordinary COVID measures — Japan first adopted a negative interest rate policy in 2016. After eight years of negative interest rates, the BOJ only hiked the policy rate to 0.1 per cent in March 2024. Restrained increases followed, up to 0.25 per cent in July 2024 and to 0.5 per cent at the start of 2025.
In its April 2025 Outlook Report, the BOJ signalled that it expected the consumer price index (CPI) to range between 1.5–2.5 per cent for the next two years. This projection would see inflation remain pinned within a ‘normal’ range for the first extended period since the early 1990s.
Sustainably anchoring inflation to Japan’s 2 per cent target would be a significant achievement, particularly if it is accompanied by steady wage growth.
The 2025 spring labour-management wage negotiations (Shunto) could see wages increase by 5.4 per cent on average. This represents a jump from the increase of 5.2 per cent in 2024, while the 3 per cent hike in 2023 was the highest in 30 years. This is a promising sign that higher inflation is consistently being met with sustained nominal wage growth.
Consumer spending has started to pick up too. Adjusting to exclude tourism, quarterly real consumer spending has grown 1.3 per cent in the last 12 months. Despite this, spending activity remains 3.9 per cent lower than in the second quarter of 2019.
There is also some evidence to suggest that inflation has started to embed itself into household expectations. In the first quarter of 2025, 86.7 per cent of Japanese households expected prices to rise in the following year. By comparison, 62.4 per cent of households reported the same at the start of 2021.
Meanwhile, long-term interest rates have been steadily rising since 2022. 10-year government bond yields reached their highest levels in over a decade in March 2025, hitting 1.59 per cent on 27 March. Rising yields are in part a response to higher inflationary expectations and are an indicator that moderate inflation can be sustained.
Embedded inflation expectations also pose a significant fiscal risk, given Japan’s high levels of public debt. Higher long-term yields are clearly front of mind for the BOJ. It opted to slow the pace of reducing its bond purchases in its June meeting, following the recent spike in long-term yields.
The Bank also outlined its intention to increase government bond purchases in the event of a rapid rise in long-term interest rates. This move underscores its commitment to financial stability amid its broader goals for normalisation. A sensitive bond market could put the BOJ in a monetary policy straitjacket.
Looking ahead, the turbulent state of global trade has emerged as the leading obstacle to further rate hikes in the near term. Increased input prices and heightened uncertainty induced by US trade policy is likely to constrain global economic growth. This will in turn dampen the domestic economy.
Despite highlighting the uncertainty emanating from global trade policy, the BOJ is prepared to continue raising the policy rate in the medium term if economic conditions hold.
Speculation that inflation in Japan has officially returned to normal is increasingly justified. Growing wages, optimistic outlooks and a higher-than-expected core CPI print in May (3.6 per cent) are strengthening this case.
Monetary conditions have remained far looser in Japan than in the rest of the developed world, with de facto quantitative tightening representing a new challenge. The deep uncertainty that has characterised the global economy in 2025 forges a narrow path for the BOJ to walk. The lethargy of the last three decades casts a long shadow over the Japanese economy — there are tests yet to come before it can truly be concluded that inflation is here to stay.
James Ghusn is Associate at Mandala, an Australia-based economic consultancy.
Source: East Asia Forum
