By Leika Kihara

TOKYO (Reuters) – The Bank of Japan (BOJ) stated that increasing wage hikes are supporting consumption and encouraging more firms in regional areas to transfer rising labor costs, indicating economic progress toward meeting the conditions for additional interest rate hikes.

However, the central bank cautioned that many small and medium-sized enterprises struggle to generate sufficient profits to raise wages, an issue that “requires vigilance.”

“This year’s wage increases were helping to boost consumption, with some companies noting solid spending by younger generations enjoying substantial pay rises,” the BOJ reported on Monday in its quarterly regional economic assessment.

This report will be one of the factors the BOJ considers in its upcoming policy-setting meeting on October 30-31, during which the board will review its growth outlook quarterly.

A majority of economists surveyed by Reuters from September 4-12 expected the BOJ to implement another rate hike by the end of the year.

In the report, the BOJ upgraded its assessment for two of Japan’s nine regional areas and maintained a moderate recovery view for the other regions.

After eliminating negative interest rates in March, the BOJ raised its short-term rate target to 0.25% in July, believing Japan is on track to meet the 2% inflation target sustainably.

BOJ Governor Kazuo Ueda indicated the readiness to further raise rates if expanding wage hikes support consumption and enable companies to continue raising prices for both goods and services.

“An increasing number of firms are likely to feel the need to continue increasing pay” in next year’s annual wage negotiations due to labor shortages, although some report weak profits hindering salary increases, according to the report.

“While some companies struggle to pass on expected rises in labor costs, a growing number in the service sector are either doing so or contemplating it,” the report indicated.

Japan’s economy grew at an annualized rate of 2.9%, driven by strong consumption, with core inflation remaining above the BOJ’s 2% target, sustaining expectations for further rate increases.

However, weak demand from China, slowing growth in the U.S., and the yen’s rebound cast uncertainty over the export-driven economy.

Governor Ueda noted that the BOJ can take its time assessing the effects of economic uncertainty in the U.S. on rate hikes, signaling no hurry to increase borrowing costs.

In the report, the BOJ upgraded its output assessment for the central Japan region, where auto giant Toyota Motor Corp is located, as disruptions in auto manufacturing resolve.

Kazushige Kamiyama, the BOJ’s branch manager for western Japan, pointed out that many firms still see excessive yen depreciation as a bigger risk than the currency’s recovery.

“A significant number of firms seem to agree that a substantial yen decline is problematic,” Kamiyama said at a news conference. Nonetheless, he noted increasing awareness among businesses of uncertainties stemming from the Chinese and U.S. economies.

“Many firms are crafting their business strategies based on the assumption that the downturn in exports to China will persist for some time,” Kamiyama added.