Our economic outlook for Japan

The Middle East conflict poses the greatest growth headwind for Japan, given its heavy energy dependence. Its sizeable strategic oil reserves—equivalent to around 254 days of consumption—should cushion domestic supply, but a prolonged blockade could prove detrimental. We have downgraded our 2026 GDP growth forecast by 0.2 percentage points to 0.8%. While the potential economic impact is not negligible, it still appears to be within a manageable range, reflecting improved energy efficiency and structural resilience. However, risks could rise materially because of weaker global demand or sustained supply disruptions.

Japan’s inflation had been easing because of government price‑relief measures, but they have been partially offset by higher oil prices and a weakened yen, pushing headline CPI higher in the near term.

Meanwhile, Shunto wage negotiations point to a third straight year of roughly 5% hikes, highlighting acute labor shortages and a strengthening wage-price cycle. This has reinforced confidence at the Bank of Japan (BoJ) that underlying inflation will remain close to 2%, with inflation expectations increasingly anchored on the upside.

Amid sustained wage growth, the BoJ is laying the groundwork for a gradual resumption of policy tightening this year. Mindful of yen volatility and energy‑price risks, we expect the BoJ to raise rates twice in 2026, taking the policy rate to 1.25% by year‑end, provided progress toward price stability remains intact.