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Jobs, not market volatility, will sway BOJ

A general view of headquarters of the Bank of Japan in Tokyo, Japan.
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A general view of headquarters of the Bank of Japan in Tokyo, Japan.

For rate setters at the Bank of Japan (BOJ), financial markets could play second fiddle to the labor market, economists say.

Expectations for additional monetary stimulus at the end of the BOJ's two-day policy meeting on Friday have grown amidst a slide in Japanese assets, and BNP Paribas places the odds of a move close to 50 percent.

Year-to-date, the Nikkei has tanked more than 10 percent while the safe-haven yen is 1.2 percent higher against the greenback in a blow to corporate sentiment. Domestic exporters, whose overseas earnings have been boosted by a weaker currency since Abenomics began three years ago, especially at risk.

The latest blow came Thursday when Japan's economy minister Akira Amari resigned amid allegations he received bribes from a construction company, hardly a conducive backdrop given the market tumult.

Moreover, extended declines in crude oil prices could force the BOJ to cut its inflation forecast below 1 percent for the coming fiscal year, threatening Governor Kuroda's goal of hitting the government's 2 percent inflation target by the second half of 2016.

While a new round of quantitative easing (QE) would temporarily help to offset adverse impacts from these developments, Japan's stable labor market will see the BOJ adopt a 'wait-and-see' approach to easing, according to HSBC economist Izumi Devalier.

The BOJ's argument for a continued improvement in underlying inflation relies on healthy employment gains, which is currently being driven by the non-manufacturing sector, she explained in a recent note.

"The resilience of the non-manufacturing sector is key to the BOJ outlook...The relative strength of non-manufacturing activity underpins the BOJ's confidence that labor markets will remain tight even if growth stays sluggish since it is the non-manufacturing sector that has been responsible for the bulk of job creation in this cycle."

In turn, that underpins expectations of an increase in wage-driven core inflation pressures, she added.

Recent data reflect the non-manufacturing sector's health. Activity in services, which accounts for around 65 percent of economic growth, expanded for the ninth straight month in December, with new business growth hitting a four-month high.

Japan's overall labor market has become tight since the advent of Abenomics in 2013, with the unemployment rate around 3.3 percent as of November 2015 versus 4.2 percent in January 2013.

Alicia Garcia Herrero, chief economist Asia Pacific at Natixis, agreed that jobs are the key metric to focus on given the new importance of wage developments for the BOJ.

"The Bank of Japan seemed to have shifted gears," she explained in a report. After the introduction of QE, Governor Kuroda emphasized lifting inflation expectations to stimulate demand but now, his main focus has changed to salaries, she said.

Herrero sees the BOJ remaining on hold until the completion of national wage negotiations—or shunto—which begin this week. Every year, companies belonging to the Japan Business Federation that report higher earnings are pushed to raise employee salaries and bonuses at the request of Prime Minister Shinzo Abe as he seeks to boost personal consumption levels.

But there's a chance shunto wage increases may end up only applying to large companies, which will massively reduce the trickle-down effect on consumption, Herrero warned.

Overall, wages haven't grown much since Prime Minister Shinzo Abe came to power.

Japan Macro Advisors

After the latest figures revealed a 0.4 percent annual dip in November real wages, the first fall since June 2015, little progression is expected going forward.

"The turbulence in the financial market in 2016 and the apparent rise in uncertainty regarding the global economic outlook is likely to make Japanese corporate managers even more cautious in raising wages. It seems that the chances are rather slim that we see any marked acceleration in wage growth in the next 3-6 months," said analysts at Japan Macro Advisors in a note last week.

HSBC's Devalier is slightly more optimistic, anticipating a gradual acceleration in per-worker wage growth as the unemployment rate drops below 3 percent.

Jobs aside, the BOJ can't remain entirely immune to intensifying global market risk aversion. Should the yen continue rising, it could reduce export demand, lower underlying inflation and see companies become reluctant to raise wages.

"These developments could even throw back the Japanese economy into a prolonged deflation. Under this risk scenario, the BOJ is anticipated to decisively expand the size of the QE," warned Herrero.

Before he announced his resignation, Amari had said the BOJ doesn't signal its intentions to markets in advance, as European Central Bank President (ECB) Mario Draghi did last week.

"The ECB's style is quite bold, but I don't think the BOJ would adopt this approach."

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