Japan's Deflationary Cycle Ends with Interest Rate Hike

Japan's economy has been stuck in a state of 'deflation' since the mid-1990s, where prices and wages remained virtually unchanged. This deflationary equilibrium was maintained by companies keeping prices fixed and labour unions accepting little or no wage growth.

The Bank of Japan (BoJ) implemented an ultra-low-interest rate strategy from 2000 onwards to break this cycle, but it wasn't until Russia's invasion of Ukraine in February 2022 that inflation began to rise. The surge in global inflation triggered a similar increase in Japan, with households and firms expecting higher prices.

As labour unions demanded and secured larger wage increases in 2023, wages and prices began to move away from the zero-growth norm. In March 2024, the BoJ raised its policy rate for the first time since the deflationary era, marking the beginning of interest-rate normalisation.

Experts attribute Japan's normalisation to both external factors, such as deglobalisation and reshoring, and domestic factors, like labour shortages resulting from a shrinking population and workforce. The inflation that began in Europe and the US in 2021 partly reflected this structural shift.