Business activity continues to expand, but rising operating costs and weakening consumer demand are complicating Tokyo’s attempt to secure sustainable growth.
Japan’s service-sector economy remained in expansion during July, but its loss of momentum and a sharp increase in business costs have renewed concerns that inflation could weaken household demand and place additional pressure on the country’s fragile recovery.
The final S&P Global Japan Services Purchasing Managers’ Index fell to 51.2 in July from 52.2 in June. Although any reading above 50 indicates growth, the decline showed that activity was expanding more slowly than previously estimated. It also undershot the preliminary reading of 51.9.
The results reveal an economy moving in two directions. Japanese businesses are continuing to report higher output, supported by manufacturing, tourism and corporate investment. At the same time, consumers and service providers are confronting elevated prices for energy, imported materials, transport and labour.
Cost pressures were particularly significant in July. Companies reported that expenses remained high across both manufacturing and services, encouraging many businesses to increase their own selling prices to protect profit margins. S&P Global said Japan’s manufacturing output expanded at its strongest pace since early 2014, but warned that some of the increase reflected precautionary stockpiling of oil-based products rather than a durable improvement in final demand.
This distinction is important for Japan, where policymakers have spent years attempting to replace deflation with moderate, wage-supported inflation. Rising prices can be beneficial when they are accompanied by stronger salaries, investment and consumption. They become more damaging when they are driven primarily by imported fuel and raw-material costs.
Recent evidence suggests that Japan is experiencing elements of both forms of inflation. Large companies have increased wages following annual negotiations, helping some employees recover purchasing power. However, many smaller businesses and lower-income households remain under pressure because everyday expenses have risen faster than their disposable income.
The Japanese government recently reduced its growth forecast for the current fiscal year as higher energy costs weighed on household consumption and corporate investment. Private consumption is now expected to increase by 0.9 per cent, down from an earlier projection of 1.3 per cent, while anticipated capital-expenditure growth has been lowered from 2.8 per cent to 2.3 per cent. Consumer inflation is forecast at 2.2 per cent, above the government’s previous estimate of 1.9 per cent.
The weaker outlook highlights Japan’s exposure to international energy markets. The country imports most of the fuel required to power its economy, leaving businesses and consumers vulnerable to changes in oil and natural-gas prices. A weaker yen can intensify that pressure by making imports more expensive.
Currency instability has therefore become a central economic concern. The yen recently strengthened following indications of official support, but it remains vulnerable to differences between Japanese and international interest rates. A persistently weak currency benefits major exporters by increasing the value of their overseas earnings, yet it also raises the domestic cost of food, energy and industrial components.
The Bank of Japan must now decide how quickly to continue normalising monetary policy. Higher interest rates could support the yen and reduce imported inflation, but they would also increase financing costs for households, companies and the heavily indebted government.
The central bank’s challenge is especially difficult because Japan’s recovery remains uneven. Exporters and advanced manufacturers are benefiting from demand for semiconductors, automation equipment and artificial-intelligence infrastructure. Tourism has also remained an important source of revenue.
By contrast, domestic consumption has been less convincing. Consumers have become increasingly selective, while businesses in retail, hospitality and other labour-intensive industries face the combined burden of higher wages and more expensive supplies.
Japan’s July purchasing managers’ surveys do not indicate an imminent recession. The service sector is still growing, factories are increasing production and business confidence has not collapsed. Nevertheless, the data suggest that the quality of the expansion is becoming as important as its pace.
A temporary rise in output caused by stockpiling or export demand will not necessarily produce a lasting recovery. Japan requires sustained wage growth, stronger household spending and productivity improvements capable of allowing companies to absorb higher costs without repeatedly increasing prices.
The economy is therefore entering a delicate phase. Japan has largely escaped the deflationary environment that defined much of the past three decades, but it has not yet secured the broad-based domestic growth that policymakers hoped would replace it.
The next stage of the recovery will depend on whether wages can consistently outpace inflation. Without that improvement, rising prices may continue to erode consumer confidence, leaving Japan with an economy that is expanding on paper while many households feel increasingly constrained.
