Expect sentiment to broadly decline. Manufacturers are not doing well due to the Middle East conflict pushing up commodity prices and scrambling supply chains. The Tankan was conducted through June, so the conflict's impact will be reflected. More fundamentally, corporates view geopolitical disruptions as here to stay, weighing on small and midsize firms. Non-manufacturing will also be impacted: higher energy costs raise costs across the economy and make travel to Japan more expensive; visitor arrivals have flatlined.

The weak yen is a double-edged sword. It benefits multinational exporters (profits look bigger in yen terms). But SMEs depend on imports and domestic demand, which is missing in action. Their ability to absorb or pass on commodity price increases is limited. This speaks to how K-shaped the Japanese economy has become: exporters plugged into AI are doing great; everybody else, not so much.

It's not happening enough. Wage growth overall is not keeping pace with GDP or profit growth, nor with inflation. Real wages are still below pre-pandemic levels. 2026 was supposed to be the year households finally see real wage growth, but with a fresh jump in inflation, that scenario is pushed into the distance. Domestic demand remains weak.

Addressing the K-shaped economy is a job for fiscal policy. For BOJ policy: they still want to hike, but it's not clear how far they will go. They will move gradually. Our forecast is for another hike in December, fitting the six-month cadence. The BOJ doesn't find the neutral rate estimate useful; they will hike step-wise and look for signs of how the economy reacts.