By Megumi Fujikawa
TOKYO--A key gauge of business sentiment in Japan improved for a fourth straight quarter even as war in the Middle East raises price pressures, keeping the central bank on track to continue raising rates.
The Bank of Japan's tankan survey showed that sentiment among large manufacturers picked up in the first quarter of the year, hitting its highest level since December 2021.
The headline index, which represents the percentage of major manufacturing firms that said business conditions were favorable minus those that said conditions were unfavorable, rose to +17 from +16 in the prior quarter.
"Overall, the latest tankan is seen as a factor that slightly raises the probability of an April interest-rate hike by the BOJ," said Mizuho Securities economist Ryosuke Katagi, noting the resilience of business confidence and firms' outlook for prices.
Still, sentiment in the oil-related sector deteriorated sharply amid market volatility, signaling that some businesses are starting to feel the pinch from the fallout of the conflict.
As geopolitical risks raise fears of an energy shortage and an acceleration in inflation, investors are pricing in a greater chance of a BOJ rate hike in April. The central bank has been signaling concerns that higher energy prices could feed through to Japan's underlying inflation.
The tankan showed that companies anticipate that overall prices will climb 2.6% over the coming year, well above the central bank's 2% target and faster than the 2.4% pace forecast in the previous survey.
Private-sector data echoed these inflationary concerns, indicating mounting cost pressures.
Data from S&P Global showed that Japan's manufacturing sector continued to grow in March, but at a slower pace as factory output and new orders cooled.
The immediate impact of the war is already feeding through to price indicators, said Annabel Fiddes at S&P Global Market Intelligence.
"Input prices rose to the greatest extent in over a year-and-a-half, leading firms to raise their charges at a quicker pace as they sought to protect their margins," she said.
Geopolitical conflict has fueled greater uncertainty about the global outlook, resulting in more cautious hiring and purchasing activity, Fiddes added.
That wariness was also evident in the tankan, which showed that large manufacturers' confidence in their business prospects for the three months ahead declined to +14.
The pullback highlights the difficulty in predicting the outcome of the Middle East war, and the impact of surging crude prices and supply-chain disruptions on Japan's industries.
Given the fragile economic outlook, some economists warn that rushing to tighten monetary policy might be unwise.
It would be premature to pull the trigger on a rate hike in Japan before confirming the trajectory of tensions in Iran and crude oil prices, especially when inflation expectations aren't yet anchored at the BOJ's 2% target, said Norinchukin Research Institute economist Takeshi Minami.
He said the BOJ should remain on hold in April to ensure that energy costs and supply constraints don't stifle the rise in underlying inflation--a measure policymakers watch closely as it strips out volatile components like energy.
Policymakers and economists are monitoring how the situation in the Middle East will affect Japanese companies' investment and earnings plans in the new fiscal year that began on April 1.
For now, corporations are expected to continue making steady investments on the back of solid earnings. Large firms plan to increase capital expenditure by 3.3% in the current business year, the tankan showed, compared with the 10.9% rise planned the previous year.
Companies usually raise capex plans later in the year after gaining more clarity on business conditions.
According to the tankan, major manufacturers forecast a roughly 2% drop in ordinary profits this fiscal year, based on the assumption that the dollar will average 148.88 yen. Since the yen is currently weaker than that, profit expectations could be revised upward if the currency remains near current levels. The dollar last stood at 158.61 yen.
Write to Megumi Fujikawa at megumi.fujikawa@wsj.com
(END) Dow Jones Newswires
03-31-26 2340ET
