Economic and Price Outlook: October Main Views

The economy is recovering moderately despite weakness in some areas, and overseas economies are also growing moderately overall. Exports are increasing against a backdrop of AI-related demand; corporate profits are at a high level, and business sentiment is favorable. Business investment is on a moderate upward trend, and private consumption is firm, supported by improvements in the employment and income situation, while housing investment is declining and public investment is broadly flat. Labor supply and demand are tight, and financial conditions are accommodative. The year-on-year rate of increase in the consumer price index (excluding fresh food) and inflation expectations are both around 2% at present.

In fiscal 2026, rising energy and raw material prices since early spring will weigh on corporate profits and households' real income, but AI-related demand, improvements in the employment and income situation, government measures, and accommodative financial conditions will support the economy, allowing moderate growth to continue even as the growth rate slows. From fiscal 2027 onward, the effects of higher energy and raw material prices are expected to diminish, while a stronger income-to-spending cycle gradually raises the growth rate. The potential growth rate is expected to remain slightly positive.

The year-on-year increase in the consumer price index (excluding fresh food) is projected to rise to a level clearly above 2%, reflecting the pass-through of wage increases to prices, higher crude oil prices, rising semiconductor prices, and past yen depreciation, and then narrow to around 2% as the effects of higher crude oil prices fade. With labor shortages, a mechanism in which wages and prices rise moderately while taking cues from each other is expected to operate, keeping the underlying rate of increase broadly consistent with the price stability target.

The outlook does not incorporate a reduction in the consumption tax rate on food and beverages. A mechanical calculation assuming changes apply to all covered items, based on the tax reform outline, would lower the fiscal 2027 year-on-year consumer price increase by around -1.3 percentage points for the index excluding fresh food and around -1.4 percentage points for the index excluding fresh food and energy. This is likely to act in the direction of boosting the economic growth rate, although the extent is highly uncertain.

In the corporate sector, exports are expected to increase moderately, supported by AI-related demand despite the effects of the Middle East situation, and corporate profits are expected to remain high even with deteriorating terms of trade. The resolution of order backlogs, government economic measures, and accommodative financial conditions will support business investment. In the household sector, nominal wages are expected to increase steadily amid tight labor supply and demand and base pay increases at around the previous year's level. Consumption is expected to remain broadly flat due to rising prices and weather factors, while supported by wages, wealth effects from stock prices, and government income transfers. Housing investment is expected to decline moderately, reflecting housing prices and demographic trends; public investment is expected to be flat, and government consumption is expected to increase moderately, reflecting medical and nursing care costs and defense-related spending. From fiscal 2027 onward, investment in labor-saving measures, AI and data centers, and responses to changes in trade structures and supply chains will support business investment, while private consumption is expected to return to a moderate upward trend as the pace of price increases settles.

Crude oil prices are assumed to decline toward the end of the projection period, with reference to futures markets and other indicators, but domestic companies' procurement prices are expected to fall less than international market prices because of transportation costs for alternative sourcing and other factors. Measures to ease energy burdens, such as fuel oil subsidies, and free education policies will push down consumer prices in fiscal 2026. The consumer price index excluding energy is also expected to have exceeded 2% due to higher crude oil prices, semiconductor prices, and yen depreciation, before its rate of increase slows as the effects of higher crude oil prices fade. Compared with the previous outlook, the growth rate is broadly unchanged over the projection period; the consumer price index (excluding fresh food) is somewhat higher in fiscal 2027, while the same index excluding energy is broadly unchanged. The output gap is expected to remain slightly positive, and labor supply and demand are tighter still.

The main risks are the Middle East situation, AI-related demand, and foreign exchange rate fluctuations. The Middle East situation is uncertain and crude oil prices are highly volatile; if procurement costs rise further amid supply concerns and declining inventories, they could weigh on corporate profits and households' real income more than assumed. AI investment could boost the global economy, but if returns do not match investment, it could create adjustment pressure accompanied by asset price fluctuations. If demand for AI-related materials and components rises more than assumed, it could also lead to price increases across a wide range of items. Yen depreciation supports the profits of global companies, but through import prices it could weigh on households' real income and small and medium-sized enterprises' profits, and could feed through to prices via pass-through. Other risks include changes in global financial conditions, fiscal expansion, China's growth and excess supply, grain prices, and geopolitical risks. Over the long term, labor shortages could both increase labor-saving investment and growth expectations, and constrain growth if substitution between capital and labor does not advance, limiting supply.

Monetary policy is conducted under the price stability target, with assessments based on two perspectives. The first perspective examines the central outlook and financial conditions. Although real interest rates are rising, they remain low, particularly at short maturities, and interest costs relative to corporate profits are also low. Demand for funds is increasing, financial institutions are taking an active lending stance, and conditions for issuing commercial paper and corporate bonds are favorable; thus, financial conditions remain accommodative. The second perspective assesses risks relevant to policy management. Financial intermediation is smooth, there are no major imbalances, and the financial system maintains stability and an adequate degree of resilience, while the Bank monitors real estate and stock prices, the Middle East situation, the profitability and financing of AI investment, and developments among overseas nonbank financial institutions. To achieve the price stability target in a sustainable and stable manner, the Bank of Japan intends to raise its policy interest rate and adjust the degree of monetary easing in response to economic, price, and financial conditions; the timing and pace will be considered after assessing the likelihood of realizing the outlook and its risks.