Japanese Business Sentiment Climbs to 4-Year Peak, Paving Way for BOJ Rate Hike

Gerik

Summary:

Japanese manufacturers’ sentiment reached its highest point since 2021, bolstering expectations for a December rate hike by the Bank of Japan, though firms remain cautious about future conditions due to labor shortages and trade concerns....

Business Confidence Rises as Japan Navigates External Pressures

In the final quarter of 2025, business confidence among large Japanese manufacturers rose to its highest level in four years, with the Bank of Japan’s December Tankan survey reporting a sentiment index of +15, up from +14 in September. This marks the third consecutive quarterly improvement, indicating that firms have thus far absorbed the impact of increased U.S. tariffs without a significant decline in operational outlook. The figure aligned with market expectations and reflects continued resilience in Japan’s industrial sector.

Non-manufacturers maintained a robust sentiment index of +34, unchanged from the previous quarter. This consistency across both manufacturing and service sectors provides support for the prevailing market view that the Bank of Japan will proceed with a policy rate hike during its December 18–19 meeting. The central bank is reportedly preparing to raise its short-term policy rate from 0.5% to 0.75%.

Strength in Capital Investment Supports Policy Shift

In addition to rising sentiment, capital expenditure projections further reinforce expectations of monetary tightening. Large firms anticipate a 12.6% increase in capital investment for the fiscal year ending March 2026, surpassing the median forecast of 12%. This commitment to investment suggests business confidence in underlying demand conditions, despite ongoing external uncertainties.

The Tankan survey also revealed that firms observed rising sales prices in the fourth quarter and expect this trend to persist in the near term. This ability to pass on higher costs indicates that pricing power remains intact, a key condition that allows the central bank to continue phasing out its ultra-loose monetary policy framework.

Short-Term Optimism Dampened by Medium-Term Caution

Despite these positive indicators, Japanese businesses expressed concern about worsening conditions in the next three months. These concerns primarily relate to the uncertain impact of prolonged U.S. tariff policies, subdued domestic consumption, and the persistent challenge of labor shortages. A Bank of Japan official highlighted that while trade tensions have eased, inflation and demographic constraints continue to cloud the medium-term outlook.

The index measuring labor market conditions indicated the tightest environment since 1991, during Japan’s bubble era. While such tightness risks slowing growth, analysts suggest it could also support wage inflation a necessary component in the BOJ’s framework for a sustained rate normalization process. According to Capital Economics, this wage-price dynamic could justify a further rate increase to 1.75% by 2027, assuming consistent gains in income and consumption.

Mixed Economic Signals Offer Conditional Support for BOJ Hike

Japan’s economy contracted in the third quarter as exports weakened under pressure from U.S. tariffs. However, recent data signals a potential rebound in the current quarter, with recovery in both exports and factory output. This supports the BOJ’s cautious optimism that Japan can withstand moderate tightening without derailing growth.

Nevertheless, firms remain wary of structural issues. The aging population and shrinking labor pool pose long-term challenges that may limit potential growth. These underlying demographic pressures make the current wage growth both a necessity and a constraint: while it supports policy tightening, it also reflects an economy straining to maintain productivity without sufficient workforce expansion.

The December Tankan survey reinforces expectations that the Bank of Japan will raise interest rates this week for the first time in months. Strong business sentiment, improved capital investment plans, and pricing power signal that conditions are in place for such a move. However, caution persists among firms due to trade uncertainties, soft consumption, and a critically tight labor market. The BOJ must now navigate a delicate balance normalizing policy to reflect improved fundamentals, while remaining responsive to the persistent vulnerabilities that could temper Japan’s recovery in the longer term.

Source: Reuters

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