Our economic outlook for Japan

The Japanese economy continues to expand moderately, broadly in line with the outlook of the Bank of Japan (BoJ). The June Tankan survey showed that business sentiment remains favorable, with firms maintaining a positive investment stance despite lingering uncertainty in the Middle East. Strong outcomes from the annual union wage negotiations—known as Shunto—also point to sustained underlying momentum, which should help cushion the economy against a sharper slowdown should energy prices rise further.

Fiscal support, including energy subsidies and a consumption tax cut, should partially offset the drag from higher energy costs. At the same time, the global AI investment cycle is providing an additional tailwind to external demand and business investment, supporting Japan’s medium-term growth outlook.

Although near-term inflation momentum has softened somewhat, we expect higher upstream costs to pass through gradually to consumer prices. Renewed cost pressures, combined with upside risks from exchange-rate pass-through and further services-sector price adjustments, should reinforce the BoJ’s assessment that monetary conditions remain highly accommodative and that there is scope for additional normalization.

Firms also appear increasingly willing to pass higher costs on to consumers. This suggests that increases in import and producer prices are likely to feed through more visibly to consumer prices, contributing to a renewed rise in inflation from this summer onward.

At its July meeting, the BoJ left its policy rate unchanged and adopted more hawkish guidance. The central bank slightly raised its growth forecasts for fiscal years 2026 and 2027, partly reflecting positive spillovers from stronger global AI-related demand, and judged that inflation risks are skewed to the upside. This reflects the potential for a further shift in corporate wage- and price-setting behavior, alongside continued increases in medium- to long-term inflation expectations.

We continue to expect an additional rate hike by the end of 2026, taking the policy rate to 1.25%. The timing will depend on incoming inflation, wage, and activity data, as well as the extent of yen weakness and its implications for import prices and inflation expectations.