Business confidence in Japan eases to near five-year low despite renewal of output growth

Japan's private sector output returned to expansion in April after contracting at the end of the first quarter of the year, according to the flash PMI. Growth in business activity was limited to the service sector, however, where higher staffing levels supported the latest rise in activity. Manufacturing production meanwhile continued to fall, albeit at a softer pace.

Despite the renewal of business activity growth in April, Japanese firms became less optimistic about their outlooks at the start of the second quarter of the year. Tariff-related concerns piled onto lingering worries over demographics, bringing the overall level of confidence to the lowest since August 2020.

On the inflation front, April data indicated that average input costs climbed at the quickest pace in two years, resulting in higher output (selling) price inflation. While the price trend indicated by PMI data point to the likelihood of an earlier policy hike from the Bank of Japan, diverging new orders trends - whereby higher services new business contrasted with a quicker fall in manufacturing new orders - outline the likelihood of a sustained bifurcation of sectoral performance in the coming months, thereby clouding the monetary policy outlook.

Japan's flash PMI indicate growth at the start of the second quarter

The au Jibun Bank Flash Japan Composite PMI, compiled by S&P Global, posted 51.1 in April, up from 48.9 in March. Rising above the 50.0 neutral mark in April, the latest reading signalled that Japan's private sector returned to expansion after March's brief decline. The rate of growth broadly matched the rolling 12-month average, recovering from the fastest contraction in over two years in March.

At current levels, the latest PMI reading is indicative of GDP growing at a quarterly rate of about 0.5% in March.

Services activity leads growth while manufacturing contraction eases

The latest renewal of private sector growth was driven by rising services activity. After stalling in March, activity in the service sector returned to expansion. Although modest, the rate of services activity growth was broadly similar to the 2024 average to reflect healthy growth in the sector. After labour constraints reportedly caused the stalling of services activity in March, service providers worked on hiring additional employees at a faster pace in April. The resultant rate of jobs growth was the quickest in three months. Moreover, the level of outstanding business accumulated at a softer pace even with greater inflows of new business to show that an expanded workforce had helped even with additional workloads in April.

Meanwhile, manufacturing output continued to fall in April, extending the period of contraction to eight months. The latest seasonally adjusted manufacturing Output Index was the highest in four months to signal a softer rate of decline. That said, a quicker reduction in goods new orders coupled with a continued decline in the level of backlogged work suggested that manufacturers were mainly working through existing orders to help soften the decline in production. The direct impact of tariff-related disruptions upon export demand - and an indirect impact on domestic client spending - had persisted in April, according to anecdotal evidence.

Cost pressures rise to two-year high for Japanese businesses

Turning to prices, average input costs rose at a faster pace in April. Panellists often pointed to higher raw material, transport and wage costs as driving the intensification of cost pressures. The rate at which input prices increased was the fastest since April 2023. Services firms faced the most pronounced increase in average input costs since February 2023 while manufacturers' input prices rose at a softer, but still steep, rate.

Consequent of the rapid increase in costs, Japanese businesses shared their additional cost burdens with clients. The rate of output price inflation similarly heightened mainly in the service sector, while manufacturing selling price inflation slipped to the lowest since June 2021 as competition geared up in the face of rising global uncertainty across the goods-producing sector.

Overall, the latest PMI price gauges are indicative of inflation staying elevated above the 2.0% mark in the coming months, supporting the Bank of Japan's (BoJ) tightening bias. That said, with forward-looking indicators painting an uncertain picture for the growth outlook, a more cautious stance may be adopted by the BoJ to lead to the central bank to hike next only towards the end of the third quarter of 2025.

Forward-looking indicators outline risks for further downsides and diverging sector performance

Adding to policymaker concerns will be a sustained gloom among Japanese firms. While the overall sentiment among Japanese business remained optimistic, the level of optimism continued to run at the lowest in almost five years. Survey respondents pointed to tariff-related worries affecting growth in both the manufacturing and service sector. This was in addition to long-held concerns over staffing constraints and an ageing population.

Additionally, the composite new orders index alluded to faster demand growth in April, but sector data further showed a two-track economy. A solid rise in services new business contrasted with the fastest fall in manufacturing new orders since February 2024. The trend for export orders and backlogs of work likewise diverged. This hinted at the potential for widening sectoral performance in the coming months, which will further challenge the central bank's resolve to lift rates despite higher inflation.

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Jingyi Pan, Economics Associate Director, S&P Global Market Intelligence

jingyi.pan@spglobal.com

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Purchasing Managers' Index™ (PMI^®) data are compiled by S&P Global for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.

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