Japanese business confidence improved for a second straight quarter but fell short of forecasts. The Bank of Japan’s Tankan survey, released Thursday, put sentiment at large manufacturers at 24, up two points from June but below the 25 economists expected. Large non-manufacturers came in at 35, also a point short of consensus, and both groups expect conditions to weaken by December.
The survey is the Bank of Japan’s quarterly check on corporate mood, covering more than 10,000 firms across manufacturing, construction, retail, services and finance. Responses were collected from August 26 to September 30, with a 99.4 percent response rate. It matters beyond Japan because the central bank raised its policy rate to 1.25 percent on September 18, its second hike of the year, and governor Kazuo Ueda has said further increases depend on whether wage growth keeps feeding into prices. Data due this week, starting with the Tankan, is what markets are watching for the next move.
The December outlook subindex tells the sharper story. Large manufacturers expect their diffusion index to fall to 21, down three points from the current reading. Large non-manufacturers expect a drop to 34. Firms are telling the BOJ the improvement is not built to last, a signal that matters for a central bank deciding whether to hike again in October or wait until December.
Smaller firms reported weaker conditions throughout. Small manufacturers sat at 9, and small non-manufacturers remained well below their larger peers. The gap between big exporters and domestic small business has been a fixture of the Tankan through the yen’s weak stretch, since exporters gain from a cheap currency while small importers absorb the cost.
The survey landed alongside other pressures on the calendar. Asian equities opened October on a cautious footing after a volatile September, with elevated global bond yields weighing on sentiment, and Japanese exporters are watching the US-Iran oil situation for second-round effects on shipping and energy costs.
Separate monthly data released the same day showed the September Tankan diffusion index for manufacturers at 22 in the Reuters quick survey, up from 18 in August, consistent with the quarterly reading’s direction even as it misses consensus.
Prices and investment
Input prices eased for manufacturers. The diffusion index for input cost changes among large manufacturers slipped to 71 from 76, with basic materials firms reporting a steeper drop. Output price indices held near their June levels, suggesting firms are still passing costs through rather than absorbing them. That combination, easing inputs with sticky output prices, is the margin-expansion picture the BOJ wants to see before it tightens further.
Fixed investment plans stayed firm. Large all-industry firms planned investment growth of 11.6 percent for fiscal 2026, up from the 10.6 percent reported in June. That spending plan is one of the stronger signals in the survey and supports the BOJ’s case that domestic demand can carry modestly higher rates. Financial institutions raised their own investment plans as well.
Production capacity readings stayed negative, with large manufacturers still reporting insufficient capacity on balance. That detail matters for the wage story: firms that cannot produce enough are the ones most likely to keep bidding for workers, which is the transmission the BOJ is counting on to keep inflation anchored near 2 percent.
The survey also showed firms expect the yen to average around 152 to the dollar over the fiscal year, barely changed from June’s forecast. A weak yen raises import costs and has been a persistent source of inflation pressure, which keeps the case for further tightening alive regardless of the sentiment readings.
Employment conditions remained tight, with the labor demand diffusion index holding in positive territory across firm sizes. Labor scarcity has been the quiet engine of Japan’s wage cycle, and it has not loosened in this survey. Inventory readings stayed balanced for finished goods, another sign demand and supply are roughly matched.
What it means for the BOJ
Reuters reported Wednesday, citing three sources familiar with the bank’s thinking, that the BOJ expects rate increases to come faster and more regularly in future as it pre-empts inflation overshoot risks. The same sources said the bank will likely set a high hurdle for an October hike, which becomes an option only if external shocks raise the risk of sharp price rises.
Kazuo Momma, a former BOJ executive director, put the odds of consecutive hikes at 20 to 30 percent in a Japan Times interview on September 28. Eiji Maeda, another former executive director, said the chance of an October move would rise if the yen weakened further and price pressure was confirmed in the data.
Politics has entered the picture too. President Trump raised the weak yen directly with Prime Minister Sanae Takaichi at a summit, an unusual step for an issue normally handled between finance ministers. Japanese finance minister Satsuki Katayama confirmed the exchange. The comment fuelled market bets on an October hike, since a stronger-yen-friendly US stance removes one source of restraint on BOJ tightening.
Markets have already priced part of the path. The yen strengthened toward 155 per dollar after the September hike, close to the level that preceded July’s intervention, and swap pricing now assigns a meaningful probability to a move at the October 29-30 meeting rather than treating December as the base case.
Friday’s Tokyo inflation data is the next input. Underlying inflation converging around 2 percent, combined with Thursday’s survey showing firms still confident enough to invest, gives the bank room to move. The softer December outlook argues for patience. The next policy meeting is scheduled for October 29 and 30, with the following one in December.