Japan’s Business Confidence Beats Expectations Despite Tariffs

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(Bloomberg) -- Confidence among Japan’s large manufacturers edged up in June, reflecting resilience in the face of the escalating US tariff campaign and backing the case for another Bank of Japan interest rate hike this year.

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The sentiment index for the country’s major manufacturers climbed to 13 from 12 in March, according to the BOJ’s quarterly Tankan report Tuesday, beating economists’ expectations that it’ll fall to 10. The improvement was led by steel and paper makers. The gauge for large non-manufacturers slipped slightly to 34 from 35, staying near the highest levels since the early 1990s.

A positive figure indicates that optimists outnumber pessimists. The outlook broadly remained unchanged for large manufacturers and non-manufacturers and sentiment also stayed largely the same for smaller firms.

The better-than-expected reading for sentiment at large manufacturers is likely to give BOJ Governor Kazuo Ueda confidence he can keep the debate around a potential rate hike on the agenda when his board next meets at the end of the month. The main gauge has now stayed positive for more than four years, supporting the central bank’s contention that the economy continues to recover with pockets of weakness.

“I really didn’t think we’d see improvement,” said Tsuyoshi Ueno, executive research fellow at NLI Research Institute. “The BOJ was trying to assess how much the overseas economy has affected domestic business sentiment. But so far, the effects haven’t really surfaced, so from the BOJ’s perspective, the situation probably doesn’t look too bad.”

The yen strengthened, emerging as the best performer among major currencies against the dollar. The Japanese currency advanced as much as 0.4% to 143.44 per dollar.

In the bond market, 10-year government bond futures, which had opened higher, reversed course and fell for a while, reflecting a shift in sentiment around long-term yields.

Business sentiment is a key indicator for authorities seeking to assess whether wage momentum may be sustained. The bank warned in its latest policy statement that growth may moderate as trade and other policies weigh on corporate profits. If companies see their margins squeezed, they may have to slow the pace of pay increases.

In the last two years, large companies have vowed during annual wage negotiations to give wage increases of 5% or more, the biggest gains in more than three decades. Those gains fueled hopes of a virtuous economic cycle featuring increased spending that spurs demand-led inflation.

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What Bloomberg Economics Says...

“A surprise pickup in business sentiment among large manufacturers in the Bank of Japan’s second-quarter Tankan survey suggests exporters are holding up well despite US tariff pressure. Price-related indicators, meanwhile, point to domestic inflationary momentum on track with the BOJ’s 2% target.”

— Taro Kimura, economist

Click here to read the full report

Uncertainty surrounding the outcome of the trade negotiations could still weigh on corporate sentiment. In Tuesday’s data, confidence among large carmakers and metal product makers worsened, though so far the impact appeared limited.

“Compared to the last survey, the export environment has clearly worsened,” said Ueno. “Car exporters have recently cut prices on vehicles shipped to North America by about 20%. That’s definitely hurting their profitability — some exporters are probably experiencing losses.”

Despite more than two months of talks, Tokyo has yet to finalize a deal with Washington. Japan continues to seek a comprehensive agreement that includes sector-specific tariffs, especially those impacting the vital auto industry. Without progress, the baseline duty on Japanese exports to the US is set to revert to 24% from the current 10% next week.

Even with the export outlook darkened by trade friction, companies are set to continue investing in plants and equipment. Tuesday’s Tankan report showed that large firms across various sectors intend to increase investment by 11.5% in the current fiscal year ending March, an upward revision from an 3.1% growth.

Capital spending is partly being driven by the growing demand for AI and digital transformation technologies as companies continue to contend with chronic labor shortages. The Tankan survey showed labor conditions remain tight, with the employment index for all industries at -35.

Businesses’ expectations for the annual inflation rate in five years stood at 2.3% for a second straight quarter, the highest level in data going back to 2014. That suggested progress for the BOJ in anchoring inflation around its price target of 2%.

“This shouldn’t be a huge surprise for the BOJ after they said that the economy has so far held up,” said Hiroshi Shiraishi, an economist at BNP Paribas. “But if the next Tankan survey shows a similar trend, it would lay the groundwork for a rate hike. We expect the next rate move in October.”

--With assistance from Hidenori Yamanaka and Issei Hazama.

(Updates with more details from report, economist comments.)