Sompo Institute Plus: Japan Economic Outlook March 2025

The SOMPO Institute Plus, the think tank of SOMPO Group, has published its quarterly outlook for the Japanese economy today. The report anticipates a continuation of moderate economic growth, driven by gradually improving real wages and solid corporate performance supporting business investment. However, external demand is expected to remain weak due to a slowdown in the global economy, particularly in the US and China. Inflation, as measured by the core CPI, is projected to decelerate over the forecast period. The outlook includes upward revisions for FY2024 GDP and CPI compared to the previous forecast (December 2024), but downward revisions for FY2025 GDP and upward revisions for FY2025 CPI. Key risks to the main scenario include an escalation of global trade wars and a sharp rise in domestic long-term interest rates, while upside risks involve an earlier-than-expected easing of goods price inflation and stronger wage growth in FY2026.

1. Economic and Price Outlook

1.1. Overview of Outlook (Main Scenario) and Changes from Previous Scenario

Real GDP: The report projects a gradual growth in real GDP: +0.8% in FY2024, +0.9% in FY2025, and +1.0% in FY2026.

• FY2025 Drivers: Expected recovery in consumption due to gradual improvement in real wages and moderate growth in capital investment backed by robust corporate earnings. Weak external demand due to a slightly stronger global economic slowdown is anticipated to limit overall growth.
• FY2026: Continued moderate growth supported by ongoing improvement in real wages.
• Changes from Previous Forecast: FY2024 real GDP forecast was revised slightly upward (from +0.7% to +0.8%). FY2025 forecast was revised downward (from +1.2% to +0.9%) due to lower expected exports (weaker external demand) and weaker personal consumption (higher-than-anticipated goods price inflation), despite an upward revision in government spending due to public sector wage increases.

Core CPI (excluding fresh food): Inflation is expected to moderate: +2.7% in FY2024, +2.4% in FY2025, and +1.7% in FY2026.

• FY2025: Service prices are expected to continue a moderate upward trend due to high wage increases, while the high growth in goods prices, particularly food, is expected to decelerate somewhat.
• FY2026: Service price growth is expected to remain moderate, while goods price growth is projected to shrink more significantly than in FY2025, leading to further overall deceleration.
• Changes from Previous Forecast: FY2024 core CPI forecast was revised upward (from +2.4% to +2.7%) reflecting higher-than-expected goods prices, mainly food. The FY2025 forecast was also revised upward (from +2.0% to +2.4%), primarily due to a delayed slowdown in goods price growth and higher-than-anticipated wage increases.

Global Economy:

• US: A stronger sense of slowdown is anticipated due to cooling consumer sentiment stemming from uncertainty surrounding US economic policy, and potential reluctance in capital investment.
• China: Moderate deceleration is expected despite increased fiscal spending, influenced by the sluggish real estate market and weak external demand growth.
• Exports: Projected to remain at a moderate growth pace, reflecting the global economic slowdown influenced by factors like tariffs.
• Changes from Previous Forecast: The outlook for the US and the global economy has been revised downward due to increased uncertainty regarding US economic policy, including tariffs, impacting consumer confidence and capital investment. Consequently, the FY2025 export forecast was revised downward. The FY2024 export forecast was revised upward due to retroactive revisions.

Capital Investment: A gradual recovery is expected to continue, driven by robust corporate earnings and strong business appetite for investment, particularly in labor-saving and decarbonization efforts, despite the impact of weaker external demand.

• Changes from Previous Forecast: The FY2024 capital investment forecast remained unchanged. The FY2025 forecast was slightly revised downward due to weaker external demand.

Personal Consumption: Moderate growth is projected, supported by a gradual improvement in real wages due to high wage increases, despite persistent goods price inflation and moderate service price increases.

• Changes from Previous Forecast: The personal consumption forecasts for both FY2024 and FY2025 were revised downward due to the impact of the upward revision in the goods price outlook.

Government Spending: Expected to continue a gradual increase in FY2025-FY2026, driven by public investment benefiting from economic measures and increased government consumption due to rising expenditures related to an aging society and public sector wage hikes.

• Changes from Previous Forecast: The FY2024 forecast was revised upward reflecting higher-than-expected actual government consumption. The FY2025 forecast was also revised upward, anticipating continued significant public sector wage increases based on the results of the spring wage negotiations.

1.2. Risks to the Main Scenario

• Downside Risks:Escalation of Trade Wars: If the Trump administration tolerates economic deterioration and further escalates tariff hikes, the US could enter a recession due to rising inflation and increased uncertainty. Additionally, the potential for a full-fledged trade war exists as countries take corresponding countermeasures against tariff hikes. Through these channels, global trade could significantly shrink, negatively impacting Japanese companies' exports and capital investment.
• Further Rise in Domestic Long-Term Interest Rates: Currently, long-term interest rates are rising as the Bank of Japan gradually raises interest rates. A further increase in long-term interest rates in the future poses a downside risk to corporate capital investment and the housing market.
• Upside Risks:Early Resolution of Goods Price Inflation: While it is currently expected to take longer than previously anticipated for the rebound in goods prices to subside, an earlier resolution of goods price inflation could potentially boost future personal consumption.
• Higher-than-Expected Wage Increases in FY2026: While it is anticipated for wage growth to slow down in FY2026 compared to FY2025, there is a possibility that the spring wage negotiations in FY2026 could also result in high wage increases. In such a case, future personal consumption could be pushed up.

2. Points by Sector

2.1. Government Spending

• The year-on-year growth rate of government spending (public investment + government consumption) is projected to be +1.5% in FY2024, +1.4% in FY2025, and +1.3% in FY2026.
• Public investment is expected to continue a gradual increase from FY2025 to FY2026 due to the effects of economic measures.
• Government consumption is also projected to continue a gradual increase in FY2025-FY2026 due to increased spending related to the aging population and public sector wage hikes.
• Forecasts for both FY2024 and FY2025 have been revised upward compared to the previous outlook (December 2024), reflecting stronger actual government consumption in FY2024 and anticipated continued significant public sector wage increases in FY2025 following the spring wage negotiations.

2.2. US Economy

• A growing sense of slowdown is expected due to cooling consumer confidence driven by uncertainty surrounding the Trump administration's economic policies.
• Potential for companies to hold back on capital investment is also noted.
• The ISM Manufacturing PMI remains slightly above the expansion/contraction threshold of 50 but has recently declined slightly.
• Input prices have risen somewhat significantly, potentially leading to future upward pressure on prices.
• The Consumer Confidence Index has deteriorated somewhat sharply, falling below the level seen in November of the previous year (when Trump was elected).

2.3. Chinese Economy

• Moderate deceleration is anticipated, despite expected support from expanded fiscal spending, due to the continued slump in the real estate market and sluggish growth in external demand resulting from US tariff hikes.
• While there are signs of recovery in completed home sales, pre-sales, which constitute the majority of sales, continue to decline due to a lack of confidence in developers.
• The Chinese government indicated its stance to support the economy by announcing plans to expand fiscal spending and the issuance of various special bonds in the government activity report on March 5th.

2.4. Exports

• The year-on-year growth rate of exports is projected to be +1.9% in FY2024, +1.6% in FY2025, and +1.6% in FY2026.
• Moderate growth is expected in FY2025-FY2026 due to a contraction in global trade resulting from tariff hikes and economic slowdown.
• The FY2024 forecast was revised upward due to the impact of retroactive revisions.
• The FY2025 forecast was revised downward considering the slowdown in the global economy.

2.5. Capital Investment

• The year-on-year growth rate of capital investment is projected to be +2.1% in FY2024, +1.8% in FY2025, and +2.1% in FY2026.
• A gradual recovery is expected to continue, focusing on investments for labor saving and decarbonization, supported by solid corporate earnings and strong business investment appetite, despite the impact of weaker external demand.
• The FY2024 forecast remained unchanged.
• The FY2025 forecast was slightly revised downward due to factors such as weaker external demand.

2.6. Personal Consumption

• The year-on-year growth rate of personal consumption is projected to be +0.8% in FY2024, +0.9% in FY2025, and +1.1% in FY2026.
• Recovery is expected to pick up from the latter half of FY2025 through FY2026 as real wages turn positive.
• The FY2024 forecast was lowered reflecting weak actual results.
• The FY2025 forecast was also lowered due to higher-than-expected price levels, particularly for goods, despite continued strong wage growth.

2.7. Employment and Wages

• Wage increases in FY2025 are expected to slightly exceed the historically high growth of FY2024 (Rengo's 2nd survey results show a year-on-year increase of +5.40%, compared to +5.25% in FY2024's 2nd survey). Growth is higher year-on-year across all company sizes, including small and medium-sized enterprises.
• While the momentum of wage increases is expected to continue in FY2026, the growth rate is projected to moderate somewhat due to the anticipated slowdown in the inflation rate from the latter half of FY2025 onwards.

2.8. Consumer Prices

• The year-on-year growth rate of consumer prices is projected to be +2.7% in FY2024, +2.4% in FY2025, and +1.7% in FY2026.
• Regarding goods, the pace of deceleration in growth is expected to remain gradual in FY2025 due to persistently high prices, particularly for food items such as rice.
• Service prices are expected to continue a moderate upward trend, reflecting high wage increases.
• In FY2026, the overall growth rate is expected to decelerate further as service price growth remains moderate while goods price growth is projected to shrink more significantly than in FY2025.
• Compared to the previous forecast (December 2024), the FY2024 forecast was revised upward reflecting higher-than-expected goods prices, mainly food. The FY2025 forecast was also revised upward, primarily due to the upward pressure from goods prices and also considering the upward pressure on service prices from high wage increases.
• Service prices are expected to be pushed up by the pass-through of increased labor costs due to continued wage increases.
• However, the overall growth in service prices is expected to remain moderate as the growth in goods-related factors included in dining out and household-related services (such as raw material costs for eating out) is expected to slow down.

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