Bank of Japan : Outlook for Economic Activity and Prices (January 2023, full text)

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Thursday, January 19, 2023.

Outlook for Economic Activity and Prices

January 2023

(English translation prepared by the Bank's staff based on the Japanese original)

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Secretariat of the Policy Board, Bank of Japan

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Outlook for Economic Activity and Prices (January 2023)

The Bank's View1

Summary

• Japan's economy is likely to recover toward the middle of the projection period, with the impact of the novel coronavirus (COVID-19) and supply-side constraints waning, although it is expected to be under downward pressure stemming from high commodity prices and slowdowns in overseas economies. Thereafter, as a virtuous cycle from income to spending intensifies gradually, Japan's economy is projected to continue growing at a pace above its potential growth rate.
• The year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) is likely to be relatively high in the short run due to the effects of a pass-through to consumer prices of cost increases led by a rise in import prices. The rate of increase is then expected to decelerate toward the middle of fiscal 2023 due to a waning of these effects, as well as to the effects of pushing down energy prices from the government's economic measures. Thereafter, it is projected to accelerate again moderately on the back of improvement in the output gap, rises in medium- to long-term inflation expectations and in wage growth, and a waning of the effects of the economic measures pushing down energy prices toward the middle of fiscal 2023.
• Comparing the projections with those presented in the previous Outlook for Economic Activity and Prices (Outlook Report), the projected growth rates for fiscal 2022 and 2023 are somewhat lower, mainly due to overseas economies deviating downward from the previous baseline scenario, although the government's economic measures are likely to make a positive contribution to the growth rates. The projected growth rate for fiscal 2024 is somewhat lower due to a waning of the effects of those measures pushing up the economy of the previous year. The projected rates of increase in the CPI for fiscal 2022 and 2023 are more or less unchanged, as effects such as those of a pass-through to consumer prices of cost increases led by a rise in import prices are likely to offset the effects of pushing down energy prices from the economic measures. The projected rate of increase in the CPI for fiscal 2024 is somewhat higher due to a waning of the effects of those measures pushing down energy prices of the previous year.
• Concerning risks to the outlook, there remain extremely high uncertainties for Japan's economy, including the following: developments in overseas economic activity and prices; developments in the situation surrounding Ukraine and in commodity prices; and the course of COVID-19 at home and abroad and its impact. In this situation, it is necessary to pay due attention to developments in financial and foreign exchange markets and their impact on Japan's economic activity and prices.
• With regard to the risk balance, risks to economic activity are skewed to the downside for fiscal 2022 and 2023 but are generally balanced for fiscal 2024. Risks to prices are skewed to the upside.

1 "The Bank's View" was decided by the Policy Board at the Monetary Policy Meeting held on January 17 and 18, 2023.

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I. Current Situation of Economic Activity and Prices in Japan

Japan's economy, despite being affected by factors such as high commodity prices, has picked up as the resumption of economic activity has progressed while public health has been protected from COVID-19. The pace of recovery in overseas economies has slowed. Exports and industrial production have increased as a trend, with the effects of supply-side constraints waning. Corporate profits have been at high levels on the whole, and business sentiment has been more or less unchanged. In this situation, business fixed investment has increased moderately. The employment and income situation has improved moderately on the whole. Private consumption has increased moderately, despite being affected by COVID-19. Housing investment has been relatively weak. Public investment has been more or less flat. Financial conditions have been accommodative on the whole, although weakness in firms' financial positions has remained in some segments. On the price front, the year-on-year rate of change in the CPI (all items less fresh food) has been in the range of 3.5-4.0 percent due to rises in prices of such items as energy, food, and durable goods. Meanwhile, inflation expectations have risen.

1. Baseline Scenario of the Outlook for Economic Activity and Prices in Japan A. Baseline Scenario of the Outlook for Economic Activity

Toward the middle of the projection period, Japan's economy is likely to recover, with the impact of COVID-19 and supply-side constraints waning and with support from accommodative financial conditions and the government's economic measures, although it is expected to be under downward pressure stemming from high commodity prices and slowdowns in overseas economies.

In the household sector, regarding the employment situation, the number of regular employees is expected to continue increasing, and a rise in that of non-regular employees is likely to become evident with a recovery in the face-to-face services sector. In addition, wage growth is expected to increase, reflecting tightening labor market conditions and price rises. Due to these factors, employee income is projected to continue increasing moderately. In this situation, although private consumption is expected to be under downward pressure from the real income side due to price rises, it is projected to continue increasing. This is mainly because pent-up demand is likely to materialize, supported by household savings that had accumulated as a result of pandemic-related restrictions, as the resumption of consumption activities progresses further while public health is being protected. Private consumption is also likely to be underpinned by the government's measures to reduce the household burden of higher gasoline prices, electricity charges, and manufactured and piped gas charges, and by its domestic travel discount program. In the corporate sector, although overseas economies are projected to slow, mainly due to

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the impact of global inflationary pressure and policy interest rate hikes by central banks, exports and production are likely to remain on an uptrend with the effects of supply-side constraints waning and with support from high levels of order backlogs for automobiles and capital goods. Inbound tourism demand, which is categorized under services exports, is also expected to increase, mainly in reflection of the government's relaxation of entry restrictions. Although high raw material costs are projected to exert downward pressure, corporate profits are likely to remain at high levels on the whole, albeit with variation across industries and firm sizes. This will likely occur due to continued improvement in economic activity on the back of factors such as the materialization of pent-up demand. In this situation, as accommodative financial conditions provide support and supply-side constraints wane, business fixed investment is expected to continue increasing, including investment to address labor shortage, digital-related investment, research and development (R&D) investment related to growth areas and decarbonization, and investment associated with strengthening supply chains. Meanwhile, public investment is projected to be more or less flat, with expenditure related to building national resilience continuing. Government consumption is expected to decline gradually in reflection of developments in expenditure related to COVID-19.

From the middle of the projection period, Japan's economy is projected to continue growing at a pace above its potential growth rate as a virtuous cycle from income to spending intensifies gradually in the overall economy. That said, the pace of growth is highly likely to decelerate due to a waning of the contribution from the materialization of pent-up demand, as well as to a waning of the effects of the government's economic measures pushing up the economy of the previous year.

In the household sector, employee income is likely to continue increasing on the back of a moderate rise in the number of employees associated with improvement in economic activity and of an increase in wage growth that reflects tightening labor market conditions and price rises. Supported by this increase in employee income, private consumption is expected to keep increasing steadily, although the materialization of pent-up demand is likely to slow. In the corporate sector, exports and production are likely to increase moderately with overseas economies picking up. Inbound tourism demand is expected to continue increasing. Corporate profits are likely to follow an improving trend since domestic and external demand is expected to increase and downward pressure stemming from high raw material costs is likely to wane gradually. In this situation, with support from accommodative financial conditions, business fixed investment is expected to continue increasing.

Looking at the financial conditions on which the above outlook is based, it is expected that they will remain accommodative as the Bank pursues Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, and that this will support an increase in

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