Our economic outlook for Japan

Japan’s economy is still expanding, supported by stable domestic demand and better-than-expected exports. Large manufacturers are reporting modestly firmer sentiment, and the activity of nonmanufacturers remains high. Meanwhile, investment in software and digitalization continues to offset labor shortages. For smaller firms, however, pressure on margins is keeping sentiment fragile.

While the impact of earlier shocks, including elevated import prices and food costs, is expected to fade, underlying inflationary pressures remain intact. These are driven by structural labor shortages, which are exerting upward pressure on wages and reinforcing a virtuous cycle of wage growth and price increases compared with recent decades. (Japan struggled with economic stagnation and deflation for many years in the 1990s and 2000s.)

With the peak of trade uncertainty likely behind us and the economy proving resilient, we expect the Bank of Japan (BoJ) to proceed with policy normalization, gradually moving interest rates higher as economic conditions evolve in line with its forecasts.

The BoJ may need to monitor foreign exchange developments closely due to capital market stability concerns. While the current policy stance remains accommodative, the bank’s forward guidance implies a data-dependent approach, with the potential for future adjustments should inflation expectations and wage dynamics strengthen further.