Japan’s Government Keeps Economic Recovery Scenario, Warns of Downside Risks Arising from High Costs of Living, Trump Tariffs

By Max Sato

(MaceNews) – Japan’s government maintained its cautiously optimistic assessment for the seventh straight month, saying the economy is expected to stay on a “modest recovery” track, but also warned about downside risks arising from high costs of living hurting consumption and the trade war launched by the Trump administration.

In its monthly report for March released Wednesday by the Cabinet Office, the government said the economy is “recovering at a moderate pace, although there are some areas where it is pausing.” The wording has not changed since August, when it upgraded its view, citing the effects of wage hikes in fiscal 2024 ending March 2025 and temporary income tax credits.

Looking ahead, “the economy is expected to continue recovering at a moderate pace with the improving employment and income conditions, supported by the effects of the policies.” The government has revived temporary utility subsidies to help lower electricity and natural gas bills during the winter heating season from January to March (bills paid from February to April). It is also providing cash handouts to low-income families.

Japan’s economic growth in the January-March quarter is forecast by economists to be at a standstill, posting a near-zero growth or a slight contraction, as soaring prices of food and other necessities are hurting consumers at a time when real wages are set to slip back into year-on-year declines.

Net exports are also expected to be dragged down by slowing U.S. demand and struggling Chinese recovery. There remains strong demand to upgrade factories and offices among many industries but lingering labor shortages and high construction costs are hampering a smooth implementation of capital investment. Growing uncertainties over the health of the U.S. economy and global trade could also slow capex.

Bank of Japan Governor Kazuo Ueda told a news conference on Wednesday that he will “keep in mind” heightened upside risks to inflation warned about by some BOJ board members at the latest two-day meeting among other things when he formulates monetary policy.

“I think the uncertainties over global growth are increasing but if you take a look at the domestic wage negotiations, the positive cycle is growing,” Ueda said, noting that wage hikes proposed by large firms are a little higher than expected.

The BOJ’s nine-member board voted unanimously to maintain the target for overnight interest rate at 0.5%, as widely expected, after voting 8 to 1 to raise the policy rate by another 25 basis points to 0.5% in January in a third rate hike during the current normalization process that began in March 2024. Members are closely monitoring whether expected high wage increases by major firms will spread to smaller firms in fiscal 2025 starting on April 1 at a time when real wages are falling, which could hurt consumption further and generate deflationary pressures.

The board continues to expect inflation to be anchored around its 2% target by early 2026, saying, “In the second half of the projection period (from fiscal 2024 through fiscal 2026 ending March 2027), underlying CPI inflation is likely to be at a level that is generally consistent with the price stability target.”

The board also maintained its view that it provided in the bank’s quarterly Outlook Report issued in January: “Japan’s economy is likely to keep growing at a pace above its potential growth rate, with overseas economies continuing to grow moderately and as a virtuous cycle from income to spending gradually intensifies against the background of factors such as accommodative financial conditions.”

Board members warned that “high uncertainties” over Japan’s economic outlook remain. Risk factors include the impact of the protectionist U.S. trade policy and retaliation by other countries on global growth and inflation, commodity prices and domestic firms’ wage- and price-setting behavior.

For its part, the government warned against downside risks arising from “the effect of continued price increases on private consumption through a downturn in consumer sentiment and the impact of the U.S. trade policy.” It dropped to its reference to “the effects of continued high interest rate levels in the U.S. and Europe and the lingering stagnation of the real estate market in China.”

The government repeated the need to keep a close watch on “fluctuations in the financial and capital markets.” The yen has firmed to around Y149.50 to the dollar from Y158 in January but is still much weaker than the Y141 rate seen in September 2024. This largely due to the outlook that the U.S. Federal Reserve will be cautious about providing a further rate relieve amid sticky inflation while the BOJ is expected to continue raising interest rates only gradually.

The government repeated that with the Bank of Japan it “will continue to work closely together to conduct flexible policy management in response to economic and price developments.” It expects the BOJ “to achieve the price stability target of 2% in a sustainable and stable manner, while confirming the virtuous cycle between wages and prices, by conducting appropriate monetary policy in light of economic activity, prices and financial conditions.”

Ueda told reporters on Wednesday that the BOJ would not raise its policy rate just to contain a spike in the prices of rice in the aftermath of acute domestic supply shortages because “that would cool off consumption.”

“The underlying inflation is estimated to be still under 2%,” the governor said. “To put it simply, the price increase in service prices is not so strong,” he said, underscoring the slow progress in lifting regulated wages as well as underpaid workers at restaurants and tourism.

As for overseas economies, the government maintained its overall assessment for the seventh consecutive month, saying, “The world economy is picking up, although it is pausing in some regions.” The last change was made in July 2024, when the view was downgraded for the first time in 18 months.

The government continues to view the Chinese economy as “pausing” even though there is an increase in supply thanks to the effects of policy measures. It regards the U.S. economy as “expanding” while noting the Eurozone is “picking up” and Germany is struggling. It downgraded its view on South Korea for the first time in 27 months, saying “the pickup is pausing.”

Key points from the monthly report:

The government maintained its assessment of private consumption, which accounts for about 55% of gross domestic product, saying it is “picking up while weakness remains in some areas.”

Real household spending posted a second straight rise in January but at a much slower pace of 0.8% on year as many consumers slashed purchases of vegetables and fruits amid rising costs and shied away from buying appliances that were not in an urgent need for replacement. It followed an unexpected 2.7% jump and the first rise in five months in December, when consumers rushed to donate to prefectures that offer generous free goods and services in return by the Dec. 31 tax year deadline.

The core measure of real average household spending (excluding housing, motor vehicles and remittance), a key indicator used in GDP calculation, fell 0.8% on the year after rising 1.4% the previous month, when the overall spending surged 2.7%.

Total monthly average cash earnings per regular employee in Japan posted their 37th straight year-on-year rise, up a nominal 2.8% in January, after rising 4.4% in December. Base wages rose a solid 3.1% on year, from 2.6% the previous month. However, real average wages slumped 1.8% for the first y/y drop in three months after small gains of 0.3% gain in December and 0.5% in November.

The government maintained its view on industrial production.

Production posted a third straight fall on the month in January with a 1.1% slip (vs. consensus -1.4%), dragged down by lower demand for semiconductor-producing equipment and computer chips. The initial reading of a slight 0.3% gain in December has been revised down to a 0.2% dip that follows a 2.2% slump in November and a 2.8% jump in October.

METI’s survey of producers indicated that output would rebound a solid 2.3% in February, led by output of semiconductor-producing equipment and computer chips, before slipping back 2.0% in March, when vehicle and general machinery productions is seen falling.

The government kept its assessment of exports after upgrading it for the first time in 18 months in February, saying they are “showing signs of a pickup” based on trade through December, when export values rose 2.8% on year to a record high ¥9.91 trillion, leading to an unexpected trade surplus.

The latest data released Wednesday showed that Japanese export values posted a fifth straight year-on-year rise in February, up 11.4% (the highest for the month of February), after rising a revised 7.3% in January. The increase was led by continued strong demand for automobiles, semiconductor-producing equipment and computer chips. Export volumes rebounded 2.9% for the first y/y rise in four months. There appear to be some rush exports to the key U.S. market in the face of the threat of stiff tariffs on imports of steel and aluminum among other goods.

Other details:

The government’s assessment of key components of the economy in the monthly economic report:

Private consumption is “picking up while weakness remains in some areas” (unchanged; upgraded in August 2024; downgraded in February 2024).

Business investment is “showing signs of a pickup” (unchanged; upgraded in March 2024; downgraded in November 2023).

Housing construction is “largely flat” (unchanged; upgraded in August 2024’ downgraded in September 2023).

Public investment is “resilient” (unchanged; upgraded in July 2024; downgraded in October 2024).

Exports are “showing signs of a pickup” (unchanged; upgraded in February 2025; downgraded in July 2024).

Imports are “largely flat” (unchanged; upgraded Oct 2024; downgraded in February 2025).

Industrial production is “flat” (unchanged; upgraded in May 2024; downgraded in Oct 2024).

Corporate profits are “improving” vs. “improving as a whole but its pace is moderate” (the first upgrade in 18 months; last upgraded in September 2023; downgraded in December 2024).

Business sentiment is “improving” (unchanged; upgraded in December 2023; downgraded in March 2022).

The pace of increase in bankruptcies is “largely flat” (unchanged; upgraded in January 2025; downgraded in January 2023).

Employment conditions are “showing signs of improvement” (unchanged; upgraded in June 2023; downgraded in May 2020).

Domestic corporate goods prices are “rising gradually” (unchanged; last changed in September 2024).

Consumer prices are “rising” (unchanged: last changed in January 2024).