(Jan 26): Japan needs to see a 3% increase in nominal wages across the board to anchor inflation above the central bank’s 2% target, according to the International Monetary Fund’s (IMF's) No 2 official.

With inflation risks tilted to the upside and price expectations rising, wages now hold the key to whether price growth will be able to stay above 2%, according to Gita Gopinath, the IMF’s first deputy managing director. That’s particularly true given that the impact of import-driven price pressure is expected to wane, she added.

“Once you have that level of wage growth, that puts a dynamic in terms of cost pressures that firms will pass through,” Gopinath said in an interview in Tokyo on Thursday (Jan 26) to coincide with the release of the fund’s latest Article IV report on Japan. “We are seeing a possible inflection point where inflation could move durably to the inflation target of 2%.”

Elements for hitting the Bank of Japan’s long-sought inflation target are moving in the right direction, according to Gopinath. Still, it remains to be seen when or if it can be achieved, she said. The IMF’s current projections expect inflation to decelerate back below 2% by the end of 2024.

In its report, the fund recommended options for the Bank of Japan to allow more movement in long-term yields, so that it can respond to both upside and downside risks regarding inflation. The right communication is also key, Gopinath said.

“A lot of what’s going to happen in markets depends upon the Bank of Japan’s communication — how much clarity there is in terms of under what conditions will they move away from very high levels of accommodation in monetary policy, and under what conditions will they move the band around,” she said.

“Communication is going to be absolutely critical to determining whether the bands are being breached or not being breached,” Gopinath said. “This is not a simple exercise for sure.”