East Asia Econ

The inflation risks evident in the Tankan can be blamed on energy prices, but output prices actually rose more than input, suggesting that firms think they can pass costs through. That's important, when the BOJ has been warning that changes in firm behaviour mean upside risks to inflation.

Today's summary release of the BOJ Tankan shows output prices rising, inflation expectations up, and the labour market tight. At the same time, business sentiment – at least for now – remains solid. Upside risks to inflation are growing again.

More interesting than today's data releases were yesterday's BOJ documents, on trends in underlying inflation, and the summary of opinions of the March MPB meeting. The BOJ is concerned about the negative TOT shock from the Middle East, but sounds more worried about upside risks to inflation.

Headline inflation data continue to be affected by policy measures to control energy and public services prices. The underlying picture is more stable, with core private services inflation of around 2%, PT wage growth of 5%, and PMIs above 50. The big risk, of course, is the impact of the Iran war.

The backdrop to the latest oil price surge is different to that of 2022. Then, wages were barely rising. This time, wage growth is at least 2%, and not slowing. With cycle momentum picking up too, there is more of a risk that a Middle East war (if it is short) further raises nominal momentum.

The Q4 data showed corporate profits and capex remaining strong, but little change in firms' huge cash holdings. The labour share has bottomed, but isn't rising. Separate data show unemployment creeping up, which will become a bigger concern if the war with Iran causes a cycle problem.

My framework for this year is an easing of tariff and price shocks that give a boost to domestic activity. Today's February data for Tokyo show the fall in headline inflation in January is persisting. Retail sales in January did jump, but these data can be noisy. IP is trending up, but slowly.

Manufacturing sentiment is up, and falling headline inflation should further boost the mood of households too. For the BOJ, the critical issue will be whether these improvements in soft data feed into real aggregate demand, in turn supporting its confidence about the trend in underlying inflation.

Growth in Q4 was only +0.1% QoQ, but that was partly because of a running down of inventories. Underlying demand was better, and given the strength of business and consumer confidence, the outlook for growth in 2026 is more positive.

Import prices aren't rising quickly, but they do remain elevated, supporting PPI in a way that wasn't true during Japan's long deflation. More interesting now is the strength of export prices, a dynamic that boosts exporter profits, and via the terms of trade, provides a tailwind for domestic income

Takaichi's huge win comes when the cycle is looking stronger, with real wages close to rising, manufacturing sentiment improving and bank lending strong. This should give the BOJ confidence, and, with the current account surplus in 2025 reaching the highest level in forty years, also help the JPY.

With policy efforts reducing headline inflation, the bullish case for Japan is once again a rise in real wages that pushes up consumer spending and aggregate demand. The consumer confidence survey points to just that scenario, but it isn't in the hard data yet, with December retail sales still soft.

My latest video, discussing the work I've been doing looking at Japan's fiscal position.

Some of the slowdown in services PPI inflation is due to lower goods price inflation, but the combined result points to softer downstream inflation. SPPI inflation in high labour-intensive sectors is still over 3% YoY, but the recent MoM run-rate of under 2% is too low for the BOJ's inflation target

The BOJ's full outlook report that was released today includes analysis arguing that the pass-through from JPY to CPI has risen, reflecting not only greater direct effects, "but also stronger secondary spillover effects, such as more active wage- and price-setting behavior of firms"

At its meeting today, the BOJ was again more positive on the outlook, but only incrementally. However, the authorities overall have been trying to put a lid on market volatility, perhaps via intervention, but also an interview by Takaichi. Data, meanwhile, show the economy still has good momentum.

Japan's current run of PPI inflation is almost the longest since at least the 1980s, but looks well-supported. Prices have recoupled with the global cycle, and are being boosted by JPY weakness. Furthermore, while it was feared that tariffs would be deflationary, export prices are rising.

The BOJ's quarterly regional sakura report shows conditions holding up, and the dip in consumer confidence in December isn't concerning given the post-March bounce. Wage growth in November was mixed, but can be expected to rebound in December on stronger bonuses.

Headlines that the FY2026 budget is the biggest ever suit the idea of Takaichi as an Abe-style loosener. However, government expenditure is stable relative to GDP, revenue is rising more, a primary surplus is planned, and though Q125, the government received more in interest than it paid out.

Data releases the last couple of days give more evidence that tariffs haven't derailed exports or capex. Even so, the flow of funds for Q3 show corporates remain net savers. With the fiscal deficit now also now narrowing to the lowest level since the 1990s, the result is a growing CA surplus.

The BOJ has been concerned that tariffs would reduce profits, cutting into wages and capex. The Tankan shows no evidence of that: profit and investment expectations remain firm, as do inflation expectations, with the backdrop being a labour market that is tight for all industries.

In Q4 business sentiment improved, the labour market tightened, price pressures picked up, and capex intentions stayed elevated. The BOJ is set to hike on Friday. Today's survey, like other recent data, raise the risk that the bank can also send a clearer message about the outlook for rates in 2026.

My latest video, discussing the BOJ and the outlook for the JPY.

The post-August rise in PPI continued in November, with one driver being the JPY-driven rebound in import prices. All told, upstream price pressures remain firm, and suggest that CPI isn't likely to ease much over the next 6M.