Big Japanese manufacturers' business sentiment worsened to a one-year low in the three months to March, a central bank survey showed on Tuesday, a sign escalating trade tensions were already taking a toll on the export-reliant economy.
The gloom contrasted with big non-manufacturers' mood, which improved to levels unseen since 1991 on booming profits from inbound tourism and the pass-through of costs via price hikes.
However, both manufacturers and service-sector firms expect business conditions to stagnate or worsen three months ahead as soft global demand, rising costs and uncertainty over U.S. tariffs cloud the outlook, the quarterly "tankan" survey showed.
The survey, compiled before U.S. President Donald Trump's announcement last week of a plan to impose tariffs on auto imports, highlights how external headwinds are complicating the BOJ's decision around the timing of further interest rate hikes.
"Companies haven't fully priced in the impact of U.S. tariffs, which is causing a sense of alarm but not directly hitting their profits yet," said Kazutaka Maeda, an economist at Meiji Yasuda Research Institute.
"With firms offering solid wage hikes and no major surprises coming out from the tankan, the BOJ likely won't change its stance of steadily raising interest rates," he said.
The headline index measuring big manufacturers' business confidence stood at plus 12 in March, down from plus 14 in December and matching a median market forecast, the tankan survey showed.
It worsened for the first time in four quarters and hit the lowest level since March 2024 with sentiment among steel and machinery makers deteriorating amid weak overseas demand, rising raw material costs and uncertainty over U.S. tariffs.
Aside from the external headwinds, the tankan painted a not-so-gloomy picture in some key areas, with capital expenditure holding up and price hikes underpinning corporate profits.
An index gauging big non-manufacturers' sentiment increased to plus 35, the highest level since 1991 when Japan's economy was experiencing an asset-inflation bubble. This compared with plus 33 in December and a median market forecast of plus 33.
Big companies expect to increase capital expenditure by 3.1% in the current fiscal year ending in March 2026, above a market forecast for a 2.9% rise.
MAY RATE HIKE?
More firms saw output prices rise while they expect inflation to hit an average 2.4% three years from now, the highest on record, underscoring mounting inflationary pressure that may justify further rate hikes.
Marcel Thieliant, head of Asia-Pacific at Capital Economics, said the survey suggested that "an increasingly overheating economy is creating strong price pressures."
"With inflation set to overshoot the BOJ's forecasts and the tankan suggesting that price pressures will remain strong, we think there's a strong case for a rate hike at the bank's next meeting in May."
The tankan will be among key factors the BOJ will scrutinise at its next policy-setting meeting on May 1, when it will also release fresh quarterly growth and price forecasts.
Companies surveyed likely took into account Trump's decision in February to raise tariffs on imports of steel and aluminum to a flat 25%.
But most of them likely replied before Trump's announcement last week of a plan to impose tariffs on auto imports. He has also pledged to announce reciprocal tariffs on Wednesday targeting all countries.
The tankan was compiled in a period between Feb. 26 and March 31 with 70% of firms sending replies by March 12.
The BOJ exited a decade-long stimulus programme last year and raised interest rates to 0.5% in January on the view Japan was on the cusp of sustainably hitting its inflation target.
Governor Kazuo Ueda has said the BOJ will keep pushing up borrowing costs if continued wage gains underpin consumption and allow firms to raise prices.
The BOJ is caught in a dilemma. Steady rises in food prices have kept inflation above its 2% target for nearly three years which, coupled with prospects of sustained wage gains, heighten the case for a near-term rate hike.
But Trump's tariff policy has stoked fears of a downturn in Japan's fragile economy, which may warrant going slow on future rate hikes.
The tankan's sentiment diffusion indexes are derived by subtracting the number of respondents who say conditions are poor from those who say they are good. A positive reading means optimists outnumber pessimists.
