October Outlook for Economic Activity and Prices

Economic activity is recovering moderately, although some weakness has resulted from developments in the Middle East. The global economy is also growing moderately overall, despite weakness in some areas. Exports, corporate profits, and business fixed investment have been firm, as has private consumption, supported by improving employment and income conditions. Housing investment has been on a declining trend, while public investment has been more or less flat. Labor supply and demand have been tight, and financial conditions have been accommodative. The consumer price index (excluding fresh food) has recently been around 2%, as have inflation expectations.

Compared with the previous outlook, the growth rate is broadly unchanged. The forecast for the consumer price index (excluding fresh food) in fiscal 2027 has been revised somewhat upward, reflecting factors such as the rise in crude oil prices since summer.

Risks to the economic outlook are broadly balanced, while upside risks to the consumer price outlook are significant. The Bank considers that inflation expectations could rise as wage and price setting becomes more proactive, potentially pushing the underlying rate of increase above the 2% target. It therefore calls for attention to avoid adverse effects on the economy that could follow.

The Outlook for Economic Activity and Prices (October 2026) consists of the Basic View and Background Explanations. The Basic View covers: “1. Current Situation of Economic Activity and Prices in Japan,” “2. Baseline Scenario of the Outlook for Economic Activity and Prices in Japan,” “3. Risk Factors for Economic Activity and Prices,” and “4. Conduct of Monetary Policy.” The Background Explanations address the current situation and outlook for economic activity and prices, as well as financial conditions. Separate boxes discuss AI-related demand; supply constraints and business fixed investment; private consumption amid rising prices; the pass-through of inflationary pressures; assessment of the underlying rate of inflation; and evaluation of financial conditions.

In fiscal 2026, higher energy and raw material prices since early spring, following developments in the Middle East, are expected to worsen the terms of trade and weigh on corporate profits and households’ real income. Meanwhile, AI-related demand, improving employment and income conditions, government measures to ease the burden of energy costs, and accommodative financial conditions will provide support. Exports are assumed to increase moderately, corporate profits to remain at a high level, and business fixed investment to continue rising moderately despite the effects of higher construction costs. For households, nominal wages are expected to increase steadily, while consumption is likely to remain more or less flat due to rising prices and weather-related factors. Housing investment is expected to decline moderately, public investment to remain flat, and government consumption to increase moderately, reflecting medical and long-term care costs and defense-related spending.

From fiscal 2027 onward, the negative effects of higher energy and raw material prices are expected to fade, and the virtuous cycle from income to spending to strengthen. Exports will be supported by the global economy and AI-related demand, while corporate profits are expected to continue increasing as the terms of trade improve and domestic and external demand grows. Business fixed investment will be boosted by efforts to address labor shortages, investment in growth areas such as AI and data centers, and investment to adapt to changes in trade structures and supply chains. Wages will continue to rise steadily, and private consumption is expected to return to a moderate growth trend as price increases ease. The potential growth rate is expected to remain slightly positive, supported by digitalization, productivity gains, investment in human capital, and an increase in the capital stock.

The year-on-year increase in the consumer price index (excluding fresh food) is expected to accelerate to a level clearly above 2%, reflecting the pass-through of wage increases to selling prices; higher energy and goods prices resulting from rising crude oil prices; higher semiconductor prices associated with AI demand; and higher durable goods prices resulting from past yen depreciation. Thereafter, the effects of higher crude oil prices are expected to diminish, narrowing the positive rate of increase toward around 2% in the second half of the projection period. A mechanism is expected to operate in which wages and prices rise moderately while taking cues from each other amid labor shortages, with medium- to long-term inflation expectations and the underlying rate of increase remaining around 2%. The Bank considers it important to confirm that inflation settles around 2% on a sustainable and stable basis to achieve the target.

The outlook does not incorporate the temporary reduction in the consumption tax rate on food and beverages under deliberation in the National Diet, or its effects. A mechanical estimate based on the tax reform outline, assuming the change applies to eligible items, would lower the fiscal 2027 year-on-year rate by around -1.3 percentage points for the consumer price index (excluding fresh food) and around -1.4 percentage points for the same index excluding fresh food and energy. The Bank considers that this could boost economic growth, but the extent is uncertain.

The main risks identified are developments in the Middle East, AI-related demand, and foreign exchange rates. With regard to the Middle East, attention should be paid to oil supply, stockpiles, procurement costs, effects on corporate profits and households’ real income, and the spread of price pass-through. AI investment could boost exports and production, but if returns do not justify the investment, it could cause asset price fluctuations or adjustment pressures. Yen depreciation could benefit the profits of global companies, but through import prices it could weigh on households’ real income and small and medium-sized firms’ profits, and its effects are more likely to pass through to prices. Other factors to monitor include monetary and fiscal policies in various countries, the Chinese economy, grain prices, geopolitical risks, demographic trends and labor shortages, and changes in trade policy.

In conducting monetary policy, the Bank assesses its baseline outlook under the price stability target and the risks that warrant attention. Real interest rates have risen but remain low, particularly in the short-term zone, and interest costs remain low relative to corporate profits. Demand for funds is increasing, financial institutions’ lending attitudes are proactive, and conditions for issuing commercial paper and corporate bonds are favorable, so financial conditions remain accommodative. The Bank considers that the financial system as a whole maintains stability and a reasonable degree of resilience, while carefully monitoring real estate and stock prices, the profitability and financing of AI investment, and developments among nonbank institutions overseas. The timing and pace of policy interest rate adjustments will be considered after assessing the likelihood of the outlook being realized and the associated risks.