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A review of the cycle, and three scenarios for the BOJ: 1) no more hikes; 2) hikes on the back of a firm nominal cycle, and 3) tightening because it is already too far behind the curve. My base case is 2, but the factors to watch are tariffs, the labour market, and the continued weakness of the JPY.
I'm just starting to catch up with things, and one of the first things I've made sure to look through is yesterday's speech by BOJ Monetary Policy Board member Naoki Tamura. He doesn't represent the majority view, but his speeches are well worth reading, and this one was no exception.
Today's quarterly business outlook survey shows more incremental weakness in business sentiment, led by manufacturing. That's another sign that tariffs in particular have taken the edge of the cycle. However, there's not yet signs of real deterioration, which capex firm and employment still tight.
With the bigger shunto rounds since 2023, wages have tended to jump early in the fiscal year. That was true this year, with full-time regular wages in April back to the faster post-2023 trend. However, part-time wages were flat, which will matter if confidence and the cycle don't rebound in 2H25.
The tone of Ueda's speech today was rather constructive. Of course, he discussed the risks from tariffs, but didn't think they were likely to derail the economy. If some kind of Japan-US deal can be reached – and progress is reportedly being made – BOJ hikes will quickly be back on the table.
Operating profits reached another record high in Q1. Like the cycle overall, profits have been led by non-manufacturing, especially in terms of margins. That is partly due to cost-cutting, with the labour share dipping in Q1. Capex is rising, but not particularly fast, despite high cash holdings.
Tokyo data show May inflation remaining high. In other releases, unemployment is low and retail sales sluggish. Tokyo CPI dynamics are diverging from national trends, because of the stronger property market. But still, the message for the BOJ is the same: inflation is strong, but growth isn't.
Today's services PPI showed solid underlying inflation. However, the recent rebound in CPI has been driven by food prices, and in separate remarks today, governor Ueda sounded more concerned about those. With a meaningful deal on tariffs, further rate hikes would quickly come back onto the table.
BOJ core rose again in April, boosted by goods, keeping in place the cost of living squeeze that is feeding into declining sentiment. My measure of core services price inflation continues to run a bit under 2%. That's ok, but the drop in sentiment has clearly shifted risks to the downside.
Data today don't darken the price- and tariff-driven pessimism painted by the April EW survey. In the May Reuters Tankan, non-manufacturing sentiment was firm, supported in part by record tourist inflows. Manufacturing sentiment didn't drop further, and separately, export volumes for April rose.
The details of today's GDP release were decent, with capex and consumption per capita ticking up. Ordinarily, those details would matter more than the slight export-driven QoQ decline in GDP. But the fall is worrying, with the recent drop in sentiment surveys warning of a bigger decline ahead.
Tariffs are reinforcing the hit from rising prices, causing a sharp fall in corporate confidence in the April EW survey. Household sentiment was stable, but USDJPY rising back to 150 means downside risk. That keeps rate hikes on the agenda, though the BOJ would clearly like tariffs to fall first.
With the slowdown in official wage growth in the last couple of months being so sharp, and so at odds with other labour market developments, I would assume it is due to technical factors. I'd be more concerned if the new shunto isn't reflected in this month's SPPI print, and wages next month.
The tariff threat has clearly changed the BOJ's growth outlook. That has implications for inflation. However, in today's detailed outlook, the bank reiterated confidence in wage-price dynamics. While it feels even less urgency than before, the bank isn't yet calling the end of this rate hike cycle.
Like most other observers, I think it unlikely that the BOJ changes policy this week. But given domestic price developments, there isn't much room for dovishness. And if the US really wants to tackle global imbalances, it has an interest in creating the conditions that allow the BOJ to hike further.
Tokyo CPI in April was boosted by changes in official subsidies. But inflation remains broad-based. Food prices were up, and rental inflation jumped – important, given the near 25% weighting. Services inflation didn't shift much, but the trend will be clearer with April national CPI and SPPI.
Export volumes have ticked up this year, but not by enough to think that JPY weakness is finally boosting sales. That has a silver lining: just as JPY weakness didn't boost real growth, a strengthening currency won't lead to much deterioration. There will, however, be an impact on nominal earnings.
Today's CPI release was less interesting than data released earlier in the week showing a jump in part-time wage growth in March, and comments from MPB member Nakagawa highlighting upside risks to inflation.
The gap between PPI and import prices shows pent-up inflationary pressure, a dynamic that is also showing up in a renewed rise in consumer inflation expectations. These trends probably have further to run, unless there is a global recession or JPY appreciation that causes import prices to fall.
The themes in the Tankan are quite clear: labour market tightness, and rising inflation pressure. Price pressures are most obvious in the services sector, which makes sense, when this is more labour-intensive than manufacturing.
The Tankan showed another rise in price pressures, particularly in non-manufacturing, the sector where labour market conditions are also the tightest and sentiment the strongest. The details of Trump's plans could change things, but domestic dynamics keep the BOJ on track to hike again.
As would be expected, the summary of the March MPC meeting shows more concern about US policy. But this isn't a repeat of summer 2024 when the BOJ got cold feet on new rate hikes. Inflation data remain solid, and the meeting talked about upside risks for prices, driven by domestic factors.
Today's shunto 2025 results are constructive, but not a game changer. Upside risks from other dynamics are bigger: part-time wages, the output gap, inflation expectations, processed food prices, rent, and pent-up inflation pressure in both PPI and public services prices.
Today's Q1 BOS survey shows the labour market still tight, giving a flavour for the early April Tankan. February PPI inflation eased, but the break with the YoY change in import prices is sustaining. That suggests PPI is being driven by the accumulated rise in import prices since 2021.
The standout finding from this year's annual corporate survey from the Cabinet Office is the continued rise in nominal growth expectations. The five-year outlook is now almost at 3%. This is another clear sign of a rise in inflation expectations, with real growth expectations not changing at all.