Our economic outlook for Japan

Japan’s economy has continued to recover moderately, despite some weakness related to developments in the Middle East and the drag from higher crude oil prices. Corporate profits remain strong, labor market conditions and household income continue to improve, and the risk of a significant slowdown has declined. Government measures to cushion household energy costs and progress in securing alternative supplies of Middle East-dependent raw materials have mitigated downside risks. Beyond that, fiscal expansion through energy subsidies and the AI investment cycle should help offset energy-related growth headwinds.

Japan’s inflation fundamentals remain firm. According to a measure that the Bank of Japan (BoJ) watches closely, core inflation is running well above the BoJ’s 2% target, even as headline inflation has fallen below target due to government measures including food-price controls. (That measure of core inflation excludes fresh food and certain tax and policy-related factors.) The BoJ is attentive to signs of faster pass-through from higher crude oil prices into business-to-business transactions, the risk of broader consumer price increases, and continued increases in medium- to long-term inflation expectations.

The BoJ raised its policy rate to a 31-year high of 1% at its June meeting. We expect an additional quarter-point rate hike this year, though we anticipate that financial conditions will remain accommodative. The timing will hinge on incoming inflation, wage, and activity data. The extent of yen weakness and its implications for import prices and inflation expectations will also be important.