Japanese Are Hating Inflation. But Stagflation Could Be Worse

After 25 years of craving inflation, Japan’s 125 million people are having some serious buyer’s remorse.

In January, prices increased at a 4% year-on-year rate, fully double the Bank of Japan’s target. This has investors betting on additional interest rate hikes. And steps by Tokyo lawmakers to cap household costs.

Irony abounds. Japan is finally getting the inflation policymakers have been chasing for a quarter of a decade. And households are hating it.

Part of the problem is that most of the inflation from which Japan is suffering comes from abroad. It wasn’t the BOJ’s ultraloose policies that defeated deflation — it was Vladimir Putin. Global fallout from the Russian leader’s Ukraine invasion — surging energy and food costs — did what 13 Japanese governments since 1999 couldn’t.

That was the year, of course, when Japan became the first major economy ever to slash rates to zero. And, really, they’re still in that vicinity — just 0.5%.

Yet the trade war that U.S. President Donald Trump is launching in real time puts BOJ Governor Kazuo Ueda in an impossible position. Continuing to hike rates risks adding to the headwinds zooming Japan’s way.

These headwinds amount to a double whammy. With Trump threatening 25% taxes on car imports, Tokyo is realizing that the debris field will be much wider than just how much tariffs slam China.

Even as Trump’s levies slam business and household confidence, they’re also sure to boost global inflationary pressures at the worst possible moment for Tokyo. Japan is only just leaving deflation behind. Is Tokyo’s next crisis stagflation?

This risk is worth considering given the frailty of the latest of the earlier mentioned 13 governments: Shigeru Ishiba’s. With approval ratings in the 30’s and a national election scheduled for July, time isn’t on Ishiba’s side to shield Japan from the shocks to come.

Ishiba’s Liberal Democratic Party has had a dozen years to raise Japan’s economic game. Government after government opted to let zero rates and a weak yen do all the work.

That gamble left Japan uniquely vulnerable to the global inflation surge — and ill-equipped to avoid Trump 2.0’s economic revenge tour. How would Tokyo respond to a scenario where economic growth flatlines and consumer prices race higher?

Something big is catching up with Japan: the nation’s dismal productivity. It’s quite a disconnect for the third-biggest economy to be 29th in worker efficiency among the 38 members of the Organization for Economic Co-operation and Development. Even worse, Ishiba is the latest leader to have no plan to fix the problem.

Never mind how competition from China, India, South Korea and Southeast Asia is speeding up Asia’s economic clock. The other problem is Tokyo’s push for companies to boost wages to kick off a virtuous cycle of increased demand.

Over the next two months, we’ll read loads about the shunto wage negotiations that happen every Spring. Last year’s talks ended with the biggest increase in 33 years (even though average wages, adjusted for inflation, went nowhere). Another 5% increase this year, though, could be a problem.

Until now, Japan has been experiencing “cost-push” inflation as import prices surge. It’s now flirting with “demand-pull” inflation, too, if wages sprint ahead of productivity gains. Japan can surely have its economic cake and eat it too. Tokyo just needs to break through a multidimensional bureaucratic matrix that might as well have been designed by M.C. Escher. Sadly, policymakers are barely trying.

All this makes for quite an economic speedbump, one that puts an asterisk on otherwise good news. The 2.8% jump in gross domestic product in the three months through December is a case in point.

“The bottom line is that the fourth-quarter GDP release is nothing to write home about,” says Stefan Angrick, economist at Moody’s Analytics. “The upbeat headline figure masks a domestic economy still stuck in the mud.”

Tokyo’s pre-existing conditions leave it in a tough spot as Trump’s escalating trade war slams Asia. And Ishiba is too busy struggling to keep his job to do the work of raising Japan’s competitiveness.

“Consumption is weak,” Angrick says, “as pay gains have trailed inflation for the better part of three years, and sticky inflation has pushed real wage growth into the distance. Policy uncertainty is an added concern. Fiscal and monetary policy are walking a tightrope between weak real growth and stubborn inflation. And given the worsening outlook for global trade, Japan won’t be able to count on exports to pick up the slack in 2025.”

The common thread between all these governments over the last 25 years is a belief that time is on Japan’s side. Yet between China’s increasing dominance and the Trump 2.0 White House shaking up the global economy, nothing could be further from the truth. The cost of decades of complacency could be stagflation.