Our economic outlook for Japan

The Japanese economy continues to expand, as strong wage growth, recovering consumption, solid corporate investment, and increasingly supportive fiscal policy provide multiple sources of domestic demand. 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.

Inflation is becoming more broad-based and increasingly demand-driven. Services inflation still lags behind goods inflation, but as stronger wage growth supports domestic demand, firms should find it easier to pass higher labor costs through to consumer prices. Renewed cost pressures, combined with upside risks from exchange-rate pass-through and further services-sector price adjustments, should reinforce the Bank of Japan’s assessment that monetary conditions remain highly accommodative and that there is scope for additional normalization.

At its July meeting, the Bank of Japan 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 have revised our monetary policy forecasts higher. We expect two additional quarter-point rate hikes by the end of 2026, which would take the policy rate to 1.5%. And we now see the Bank of Japan’s policy rate ending 2027 at 2%.