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I. Economic Activity and Prices

A. Economic Activity

1. Current situation I will begin my speech by talking about recent developments in economic activity in Japan. Japan's economy has recovered moderately. Let me explain its current state in detail from two aspects: the household sector and the corporate sector. First, a look at the household sector. Private consumption has increased steadily at a moderate pace (Chart 1). Although some indicators suggest that the recent price rises and severe weather have been pushing down consumption, with the reclassification of COVID-19 as a Class V infectious disease under the Infectious Disease Control Law, consumption has been supported by pent-up demand on the back of household savings that accumulated during the pandemic, and also by improvement in consumer sentiment, which partly reflects the results of the annual spring labor-management wage negotiations this year. The propensity to consume, which significantly declined during the pandemic, has continued to improve, and consumers are more willing to spend.

Next, the corporate sector. Although exports and production have been affected by the slowdown in the pace of recovery in overseas economies, they have been more or less flat, supported by the waning of supply-side constraints and high levels of order backlogs (Chart 2). Corporate profits have been at high levels on the whole, although the situation varies across industries and firm sizes (Chart 3). Business fixed investment has increased moderately, and the plan for fiscal 2023 in the Tankan (Short-Term Economic Survey of Enterprises in Japan) indicates that investment is likely to increase clearly.

2. Outlook

Next, I will turn to the outlook for economic activity. Although inflation rates in the United States and Europe have become lower, inflationary pressure has remained (Chart 4). In this situation, overseas central banks have continued to raise their policy interest rates. Given these circumstances, the pace of recovery in overseas economies is projected to remain slow for the time being. Although such developments in overseas economies are projected to exert downward pressure, Japan's economy is likely to continue recovering moderately, led by domestic demand with support from factors such as accommodative financial conditions and the government's economic measures. As background to Japan's economic outlook, the following are five key developments.

First, the waning of supply-side constraints will make a positive contribution to exports and production.

Second, pent-up demand, which recently has been pushing up private consumption and business fixed investment, will continue to support the economy's recovery for the time being.

Third, inbound tourism demand will keep rising.

Fourth, business fixed investment will continue to increase, mainly on the back of high levels of corporate profits.

Fifth, as the growth rate of wages becomes higher, reflecting tightening labor market conditions and price rises, a virtuous cycle from income to spending will intensify. In terms of the median of the Bank of Japan Policy Board members' forecasts -- as presented in the July 2023 Outlook for Economic Activity and Prices (Outlook Report) -- Japan's real GDP growth rate is expected to be at 1.3 percent for fiscal 2023, 1.2 percent for fiscal 2024, and 1.0 percent for fiscal 2025 (Chart 5). As Japan's current potential growth rate is estimated to be in the range of 0.0-0.5 percent, the economy is projected to continue growing at a pace above its potential. The pace of growth is expected to decelerate slightly because the outlook factors in a waning of the contributions from pent-up demand and the government's economic measures.

Both upside and downside uncertainties exist over the outlook that I just mentioned depending on developments in overseas economic activity and prices, price developments in commodities, including grain, and firms' and households' medium- to long-term growth expectations. My view is that there is a certain degree of possibility that the growth rate will deviate upward from the Bank's baseline scenario due to factors such as (1) increases in investments associated with the green transformation and with strengthening supply chains, (2) a further acceleration of investment to address labor shortages and digital-related investment as well as the resultant improvement in firms' productivity, and (3) an intensifying virtuous cycle between wages and prices driven by such improvement in productivity.

B. Price Developments

Turning to Japan's price developments, the year-on-year rate of increase in the consumer price index (CPI) has been significantly higher than 2 percent recently; when excluding temporary factors such as the effects of the consumption tax hikes, it has been at a level that has not been seen even going back to the bubble period (Chart 6). The rate of increase in the CPI for all items less fresh food and energy, for which prices fluctuate significantly, has been at a level above 4 percent (Chart 7). This is because import prices have risen on the back of the yen's depreciation and high prices of commodities, including grain, leading to a greater passthrough of cost increases to consumer prices for a wide range of items. Looking at the breakdown of developments in the rate of change in the CPI for all items less fresh food and energy, the rate of increase in goods prices has recorded a high level of 7.3 percent; among services prices, which tend to fluctuate less, the rate of increase in general services prices less housing rent has accelerated to 4.3 percent.1

What is distinctive about the current situation is the change in firms' price-setting behavior. In Japan, firms had long been hesitant to increase their selling prices even when faced with a rise in input prices. However, because raw material costs have risen too high to be compensated for by reducing costs and curbing profits, firms have been passing on cost increases to selling prices since last year (Chart 8). This is likely because consumption has been solid even when prices have been rising, underpinned by standby funds that accumulated during the pandemic and by pent-up demand. A closer look at the increase in selling prices shows that, in addition to higher raw material prices, increases in shipping costs, utility costs, and even personnel expenses are being passed on to selling prices. Firms' outlook for output prices of their products for one year ahead in the Tankan indicates that they intend to raise such prices at a higher rate than the projected rate of increase for general prices, and I believe that this shows the firms' active stance toward passing on cost increases to selling prices.

Looking at monthly developments, the rate of increase in the CPI is likely to decelerate for the time being, with a waning of the effects of the pass-through to consumer prices of cost increases led by the past rise in import prices. Thereafter, however, the rate of increase is projected to accelerate again moderately. In terms of the median of the Policy Board members' forecasts, the CPI for all items less fresh food is projected to see a year-on-year rate of increase of 2.5 percent for fiscal 2023, 1.9 percent for fiscal 2024, and 1.6 percent for fiscal 2025 (Chart 9).

The outlook for prices is highly uncertain as it entails both upside and downside risks. In my opinion, the possibility cannot be denied that prices will rise more than expected, given that (1) firms' pass-through of cost increases to selling prices is ongoing, (2) services prices are increasing at a faster pace, and (3) sustained wage rises could be expected mainly on the back of a tightening of labor market conditions. With regard to wage increases, which considerably affect future price developments, the wage growth rate agreed in the annual spring labormanagement wage negotiations this year was significantly higher than in the previous year due to the tightening of labor market conditions and high inflation rates (Chart 10). I expect that the annual spring labor-management wage negotiations to be held next year will also result in agreement on a relatively high wage growth rate, considering that labor shortages and high inflation rates are likely to continue this year.