Japan Government Keeps Gradual Economic Recovery Outlook, Continues to Warn about Inflationary Impact of Lingering Mideast Conflict

–Government Upgrades Its View on Business Sentiment After Upbeat Q3 Tankan Survey, Downgrades Assessment of Exports Amid Sliding Volumes

By Max Sato

(MaceNews) – Japan’s government continues to see a moderate economic recovery ahead and repeated its warning about the lingering Mideast conflict that has kept global energy and transportation costs high.

In its monthly report for September released Tuesday 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.” It dropped its reference to “natural disasters” from the watch list as the economy has weathered the drag from a powerful earthquake in southwestern Japan in late July and a series of severe rain storms that battered many regions in August and September.

The near-term outlook is also unchanged, “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 reference to the recent natural disasters was left out.

The government also repeated the need to keep a close watch on “fluctuations in the financial and capital markets.” Bond yields have risen this year over fears of large fiscal spending and elevated inflation while the yen remains weak, keeping imports expensive.

The official assessment of business sentiment was upgraded for the first time in nearly three years after the Bank of Japan’s Tankan survey showed improving confidence and solid capital investment plans. By contrast, the official view on Japanese exports was downgraded for the first time in 15 months in light of falling export volumes.

The government noted that growth in consumer spending has been moderate in the face of soaring prices for food and other essentials as many firms continue to reflect higher costs in retail prices.

Data released last week showed that Japan’s consumer inflation accelerated to just above the Bank of Japan’s 2% price stability target in September as the price-cutting impact of two key fiscal support programs by the Tokyo metropolitan government had waned. The year-on-year increase in the core CPI (excluding fresh food) picked up to a nine-month high of 2.1% after unexpectedly easing to 1.7% in August and rising to a six-month high of 1.8% in July. It remains tame compared to a recent peak of 3.7% hit in May 2025.

The lingering war in the Middle East is keeping fuel and transportation costs high while the yen remains under year-earlier levels, eroding the economy’s purchasing power. Hotel charges rose on the year after falling in August thanks to strong tourism demand during the longer-than-usual Silver Week holidays from Sept. 19 until Sept. 23.

Nationwide subsidies for fuels and utilities (electricity and natural gas) are keeping energy prices below year-earlier levels, providing a slight downward pressure on overall prices. But households are expected to be hit by further markups in groceries and other necessities in coming months.

The government repeated its neutral statement that it expects the central bank to “achieve the price stability target of 2% in a sustainable and stable manner while confirming the virtuous cycle between wages and prices.”

The Bank of Japan’s nine-member board is widely expected to leave the target for the overnight interest rate unchanged at 1.25% in a unanimous or majority vote at its Oct. 29-30 meeting after raising it to the level from 1% in a 7 to 2 vote in September to keep underlying inflation from deviating upward from the bank’s 2% price stability target.

Judging from recent remarks by Governor Kazuo Ueda, the bank is on course toward lifting the short-term interest rate further to a more neutral level to reduce the degree of monetary stimulus but upside risks to inflation is not urgent enough to require a back-to-back rate hike.

On global growth, the government maintained its core assessment. “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.”

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 official assessment of business sentiment was upgraded for the first time in 34 months. It is now “improving overall” but the government quickly added that developments in the prolonged Mideast conflict need to be closely monitored. Until last month, it said sentiment was “largely flat while firms are cautious about their outlook and thus the situation in the Middle East needs a close watch.”

The BOJ’s quarterly Tankan business survey released on Oct. 1 showed that sentiment among large manufacturers rose to the highest in more than eight years in the September quarter after posting an unexpected pickup in June thanks to strong global demand for memory chips and equipment to produce them used in artificial intelligence projects.

The index measuring confidence among large manufacturers rose to 24 in September from 22 in June, reaching the highest since March 2018. It was slightly softer than expected. The improvement was led by oil refineries, still mills and non-ferrous metal producers while it was partly offset by declines in the food and lumber industries.

Sentiment among smaller manufacturers beat expectations as the Tankan index climbed to 14, the highest since December 2018, against the consensus forecast of 11 and up from 9 in the previous June survey. The larger-than-expected rise was driven by the auto industry, non-ferrous metal producers and general machinery makers.

In the September survey, large firms left their combined capital investment plans for fiscal 2026 little changed at a 11.3% increase over fiscal 2025, compared to a 11.5% rise projected in June. That was weaker than the median economist forecast of a 12.1% gain but the pace is still solid. Smaller firms revised up their plans to a 4.8% drop from an 8.3% fall, as expected.

Pointing at soft spots in the economy, the government downgraded its view on exports for the first time in 15 months, saying the pickup in exports is “stalling.” Previously, it said exports were “showing signs of a pickup.”

The Cabinet Office data showed Japan’s seasonally adjusted export volume index marked its second straight decline in September, down 0.5% on the month, after slumping 2.7% in August and rising 1.7% in July. In the July-September quarter, the index was down 1.0% from April-June, when it fell 1.3%. The index continues to increase from year-earlier levels but its pace slowed to 1.9% in September from 2.4% in August and 5.2% in July.

The BOJ’s real export value index also showed some weakness, edging down 0.2% on the month in September after slipping 0.8% in August and rising 0.6% in July. Gains in shipments to the United States and the European Union were more than offset by drops in those to China. In the July-September period, the index, however, the index rose 1.0% on quarter following a 1.3% dip in Q2 and a 2.4% rise in Q1.

Export values posted a double-digit percentage increase for the seventh straight month in September, up 16.7% on the year, as the auto industry has overcome the drag from stiff U.S. tariffs slapped last year and global demand for memory chips and non-ferrous metals remains strong, Ministry of Finance data showed. The 13th consecutive increase followed a 19.3% gain in August and was led by computer chips, automobiles and semiconductor-producing equipment, as largely seen in the prior month. Exports rose 23.2% in July to a fresh record high of ¥11.51 trillion.

The government maintained its view on industrial production after upgrading last month for the first time in 28 months, saying it output is “showing signs of picking up overall.” 

In data due on Oct. 30, Japan’s industrial production is expected to post its first increase in three months in September, up a modest 1.2% on the month, after marking a surprise second straight drop in August (revised down to -2.4% from -1.7%). The forecast rebound is likely to be led by computers, autos and production machinery but severe rain storms that battered many regions in the month appear to have hurt some factory operations and restricted supply deliveries.

Last month, the monthly survey by the Ministry of Economy, Trade and Industry indicated that output would rebound 1.6% on the month in September (adjusted for the statistics’ upward bias) and rise a further 3.1% in October, led by production machinery, semiconductors and computers.

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.”

The latest data showed that real average household spending posted its ninth straight year-on-year drop in August, down 3.1% (consensus -4.2%), after falling 3.6% in July, as consumers remained wary amid rising costs of living and stormy weather wreaked havoc in many regions. Cooler weather dampened demand for summer clothing, air conditioners and other seasonal goods.

More markups in groceries and other necessities are expected in coming months as the Iran war has boosted energy costs and the weak yen has pushed up import prices. Firms are also reflecting higher labor costs in retail prices. Consumers are also being hit by sharp price hikes for computers and smartphones amid global shortages of memory chips.

Excluding home maintenance and repairs and other volatile items like vehicles and gift money, the core measure fell 4.2% (down 2.1% in nominal terms) after falling 1.4% (up a nominal 0.8%) the prior month. Autos and related items, a widely fluctuating category, pushed up overall spending by 0.13 percentage point (mostly vehicles) after trimming July expenditures by a full percentage point (mainly vehicles).

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 “is largely flat” (unchanged; upgraded in August 2026; downgraded in August 2025).

Public investment is “firm” vs. “solid” (the first downgrade in nine months: upgraded in April 2026; last downgraded in December 2025).

The pickup in exports is “stalling” vs. exports are “showing signs of a pickup” (the first downgrade in 15 months; upgraded in June 2026; last downgraded in July 2025).

Imports are “largely flat” (unchanged; upgraded in May 2025; downgraded in November 2025).

Industrial production is “showing signs of a pickup overall” vs. “flat” (the first upgrade in 28 months; last upgraded in May 2024; downgraded in October 2024).

Corporate profits are “improving but the Mideast situation needs a close watch” (the first upgrade in six months; upgraded in August 2026; downgraded in August 2025).

Business sentiment is “improving overall but the situation in the Middle East needs a close watch” vs. “largely flat but firms are cautious about their outlook and thus the situation in the Middle East needs a close watch” (the first upgrade in 34 months; last 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 are “flat” vs. “showing a slower pace of increase” (the first change in two months; wording last changed in August 2026). 

Consumer prices are “has been rising” vs. “rising moderately” (the first change in seven months; wording last changed in March 2026).