–Government Continues to Warn About Mideast Conflict: It May Cause Widespread Consumer Goods Markups Beyond Energy Prices
By Max Sato
(MaceNews) – Japan’s government remains confident that its fuel and utility subsidies as well as solid wage hikes by many firms should support the economy’s gradual recovery from the pandemic slump while warning that higher energy costs amid the lingering Mideast conflict could trigger widespread markups in consumer prices.
In its monthly report for July released Wednesday by the Cabinet Office, the government maintained its overview, saying that the economy is “recovering at a moderate pace but the impact of the situation in the Middle East needs a close attention.”
As for the near-term outlook, the government repeated, “The improvement in the employment and income conditions and the effects of various (fiscal) policies are expected to support a moderate recovery while the impact of the situation in the Middle East needs a close watch.”
The report didn’t mention the powerful 7.1-magnitude earthquake that shook Kumamoto Prefecture in southwestern Japan on Tuesday, killing at least 13 people and injuring many more while damaging roads and cutting off electricity and water supply. It prompted automakers like Toyota and Honda and chipmakers including Renesas and Tokyo Electron to suspend production in the region for a few days. Taiwan Semiconductor Manufacturing Co. was gradually resuming operations at its Kumamoto factory after a precautionary suspension.
Judging from the impact of a disaster of this magnitude in recent years, the earthquake and aftershocks in the Kyushu region could cause a supply chain disruption on a national level for growth-leading industries and dent consumer and business sentiment.
The report came two days before the Bank of Japan’s policy decision. The bank’s nine-member board is widely expected to stand pat at its July 30-31 meeting but it has said that it will follow up with a further adjustment to what it sees as a still stimulative policy interest rate level. At its previous meeting on June 15-16, the board decided to raise the target for the overnight interest rate to 1% from 0.75% in a 7 to 1 vote (the governor was absent due to illness), citing growing upside risks to inflation triggered by the Mideast conflict.
The bank is in no hurry raise rates as inflation expectations among firms are still around its 2% price stability target and subsidies and other fiscal measures are expected to continue to offset some of the upward pressures on consumer prices. The next rate hike, a sixth in the current normalization process, is expected to take place in October or December.
The government revived temporary subsides for electricity and natural gas to help curb utility bills from July through September when extreme summer weather is expected to boost the usage of air conditioners across the country. It is also keeping a lid on the retail prices of gasoline and other fuels by applying subsides since mid-March in light of the Iran war and scrapping the decades-old gasoline surcharge at the end of 2026.
Consumer inflation accelerated slightly in June due to a smaller drop in gasoline prices and larger markups in other fuels, which limited the impact of a continued moderation in processed food markups. The year-on-year increase in the core CPI (excluding fresh food) accelerated to 1.6% after being unchanged at 1.4% in May and decelerating sharply to a four-year low of 1.4% in April from 1.8% in Mach, data from the Ministry of Internal Affairs and Communications showed.
All three key CPI measures remain below the Bank of Japan’s 2% target, thanks to fuel subsides and free high school education, both of which are partly offsetting the impact of rising costs of imports due to the weak yen, labor amid widespread worker shortages and transportation and packaging triggered by the U.S.-Iran military conflict.
On the other hand, the Bank of Japan’s own core CPI (excluding fresh food and institutional factors) rose 2.7% on the year in June after the annual rate eased to 2.7% in May from 2.8% in April. The institutional factors are: the effects of sales tax rate changes, free education, fuel and utility subsidies, reduction in mobile phone charges in 2021 and travel subsidy programs during the pandemic.
The BOJ’s another core measure, the CPI minus fresh food, energy and institutional factors, continued to slow to a 2.0% increase in June from 2.1% in May and 2.2% in April. The annual rate of the government’s core-core CPI (excluding fresh food and energy) stood at 1.7%, easing further from 1.8% in May and 1.9% in April.
The sharp depreciation of the yen compared to a year earlier is also generating a headwind for Japanese households and businesses as it makes imports more costly. The June trade data showed Japanese import values rose for the fifth straight month, surging 25.2% to a record ¥11.34 trillion, following a 9.8% increase in May. The gain was driven by higher purchases crude oil (volumes were down), computer chips and non-ferrous metals. Import values of crude oil rebounded 59.3% on the year in June, ending many months of decline (vs. -28.5% in May).
The government maintained its core assessment of global growth. “The world economy continues to show gradual recovery while some regions are showing weakness,” it said, “However, the uncertainty over the global economy including the situation in the Middle East continues.” Last month, it said the uncertainty was “growing.”
Japan sees the U.S. economy as “expanding moderately” after upgrading its view for the first time in more than two years in the June report. The official views are unchanged for the Eurozone, which is “showing signs of a pickup” and for China that is still “slowing gradually.”
Key points from the monthly report:
The government maintained its core assessment of private consumption that accounts for about 55% of the GDP, saying that it is “showing signs of a pickup.”
Real average household spending posted the sixth straight year-on-year drop in May but the pace of decline was a slight 0.4% (consensus -2.3%) as the effects of a pullback in automobile purchases and a drop in domestic traveling were partly offset by strong demand for air conditioners amid hot weather and ahead of April 2027, when the government is scheduled to introduce stricter energy saving standards. The firmer-than-expected May spending, which rose 1.4% in nominal terms, was also due to higher costs of funerals and widespread markups in private university tuition fees.
Autos and related items, a widely fluctuating category, pushed down overall spending by 2.30 percentage points after raising April expenditures by 1.42 points. Excluding home maintenance and repairs and other volatile items like vehicles and gift money, the core measure actually rose 2.6% (up 4.3% in nominal terms) after falling 2.0% (down a nominal 0.5%) the prior month.
The strength was also seen in the seasonally adjusted expenditures index, which surged 3.7% on the month to a 12-month high of 101.7 in May after rising 1.6% to 98.1 in April and falling 1.3% to 96.6 in March.
Real income growth is subdued in the face of elevated costs for daily necessities, although processed food price hikes have continued to ease and subsidies have capped fuel price rises. The May report showed spending on foodstuffs marked the first increase in four months in real terms, up 2.4% on year (+6.0% in nominal terms), as people spent more on restaurant meals and takeout food. Rising stock markets and substantial wage hikes by large firms appear to have propped up consumer sentiment.
Industry data released last week showed department store sales posted their sixth straight year-on-year rise June, up 2.3%, but the pace of increase decelerated from 8.3% in May and 5.2% in April in light of rainy and typhoon weather. There was also one less Sundays (four) compared to June last year, which also led sales to domestic customers to mark their first drop in 11 months (-0.2%).
On the upside, the weak yen kept sales to visitors from overseas above year-earlier levels for the fourth consecutive month, up 29.8%, following a 16.7% gain in May. Solid spending by those from Southeast Asia and Europe continue. Even spending by Chinese shoppers rose about 16% to record its first year-on-year increase in seven months, although the number of those from China was still down 25% as many of them are bypassing Japan at the request of Beijing over bilateral diplomatic rows.
The monthly Economy Watchers Survey, which was conducted by the Cabinet Office from June 25 to June 30 and released on July 8, indicated that confidence continued to improve, thanks to easing in Mideast tensions at the time as well as robust spending by visitors from overseas taking advantage of the weak yen and by affluent domestic consumers amid rising stock prices. There is also solid demand for semiconductors and air conditioners.
The Watchers’ sentiment index showing the direction of Japan’s current economic climate rose slightly to a four-month high of 44.0 in June on a seasonally adjusted basis, posting the second straight rise after rising to 43.6 in May from 40.8% in April. Before the impact of the Iran war emerged, the index climbed to a nearly two-year high of 48.9 in February from 47.6 in January. The last time the index was above the neutral line of 50 was in March 2024, when it was at 50.1.
The Watchers’ outlook index, which shows sentiment in two to three months, marked the third straight increase, rising to 45.7 in June from 40.7 in May and 39.4 in April. The index started the year at 50.1 before slipping to 50.0 in February and plunging to 38.7 in March.
The government also maintained its assessment of exports after upgrading it for the first time in 16 months in June, saying they “have shown signs of a pickup.”
Trade data released last week showed Japanese export values rose at a faster-than-expected pace of 19.3% on the year to ¥10.93 trillion in June for the 10th straight rise after rising a revised 16.8% in May as the base effect of high U.S. tariffs on autos and metals has faded and global demand for computer chips and non-ferrous metals remains strong. The June increase was led by automobiles, computer chips and non-ferrous metals, largely as seen in recent months. The June export amount was the second largest after the record high of ¥10.98 trillion in March 2026.
The government continues to describe industrial production as being “flat.”
Japan’s industrial production for June, due on July 31, is expected to post its third straight rise in June, up a modest 0.5% on the month, possibly led by a pickup in the auto sector as the base effect of stiff U.S. tariffs on vehicles and metals has waned. It also mirrors strong export demand for computer chips and non-ferrous metals. It would follow a downwardly revised slight 0.1% gain in May and a 0.5% rebound on a 0.4% dip in March.
Last month, the monthly survey by the Ministry of Economy, Trade and Industry indicated that output would rise 2.6% on the month in June, led by a rebound in the production of equipment to produce flat panel displays, general machinery to make analytical instruments and electric/telecom products (laptop computers), all of which dropped in May. Factory output was projected to be flat in July.
Other details:
The government’s assessment of key components of the economy in the monthly economic report:
Private consumption is “showing signs of a pickup but softer consumer sentiment needs a close watch” (unchanged; upgraded in September 2025; downgraded in February 2024).
Business investment in equipment and software is “picking up” (unchanged; upgraded in April 2026; downgraded in November 2023).
Housing construction “has a weak undertone” (unchanged; upgraded in August 2024; downgraded in August 2025).
Public investment is “solid” (unchanged: upgraded in April 2026; downgraded in December 2025).
Exports are “largely flat” (unchanged; upgraded in June 2026; downgraded in July 2025).
Imports are “largely flat” (unchanged; upgraded in May 2025; downgraded in November 2025).
Industrial production is “flat” (unchanged; upgraded in May 2024; downgraded in Oct 2024).
Corporate profits are “showing signs of improvement but the Mideast situation needs a close watch” (unchanged; upgraded in February 2026; downgraded in August 2025).
Business sentiment is “largely flat but firms are cautious about their outlook and thus the situation in the Middle East needs a close watch” (unchanged; upgraded in December 2023; downgraded in April 2025).
The pace of increase in bankruptcies is “largely flat” (unchanged; upgraded in June 2026; downgraded in October 2025).
Employment conditions are “showing signs of improvement” (unchanged; upgraded in June 2023; downgraded in May 2020).
Domestic corporate goods prices have been “rising” (unchanged; wording last changed in May 2025).
Consumer prices are “rising moderately” (unchanged; wording last changed in March 2026).