Business confidence among major Japanese manufacturers worsened for the first time in seven quarters in March, hurt by energy and raw material costs that surged on Russia's invasion of Ukraine and pandemic-related supply bottlenecks, the Bank of Japan's Tankan survey showed Friday.
The key index measuring sentiment among companies such as automakers and electronics makers dropped to 14 in March from 17 logged three months earlier, the lowest level since June 2021. It was above the average market forecast of 11 in a Kyodo News survey.
The index for large nonmanufacturers, including the service sector, fell to 9 from 10 in the previous survey in December, highlighting the severe blow dealt by restrictions imposed in response to the COVID-19 pandemic. The reading also marked the first deterioration in seven quarters.
The Tankan index represents the percentage of companies reporting favorable conditions minus the percentage reporting unfavorable ones.
Russia's attack on Ukraine that began on Feb. 24 has sent crude oil and commodity prices sharply higher amid a spike in geopolitical risk and supply concerns. Russia is a major exporter of crude oil and natural gas.
The yen has been falling sharply against major currencies such as the U.S. dollar and the euro, inflating the cost of imported raw materials.
"The results reflect increasing worries among companies about surging raw material costs. The situation in Ukraine and the yen's recent sharp depreciation are making it hard for many firms to be optimistic," said Toru Suehiro, a senior economist at Daiwa Securities Co.
Higher costs are threatening to erode profits with wholesale price inflation accelerating at its fastest pace in decades. Sentiment among firms in sectors ranging from pulp and lumber to chemicals and food all deteriorated.
The surge in costs comes as manufacturers have been grappling with parts shortages caused by the COVID-19 pandemic.
Japanese automakers, including Toyota Motor Corp., have been forced to cut output due to difficulty in procuring parts such as semiconductors.
Confidence in the auto sector fell further to minus 15 in March from minus 8 in December, though it is projected to improve to minus 1 in the coming months.
Economists say a growing number of companies are protecting profits by passing on higher raw material costs to consumers.
"As the infection situation stabilizes, service providers are expected to see a recovery in demand," Suehiro said. "But consumers, who have to pay more for energy and food items due to price hikes, may have to cut spending on services (such as entertainment and travel), pressuring corporate earnings over the longer term."
The lingering impact of the COVID-19 pandemic was also felt among service providers including hotel operators, restauranteurs and retailers, as anti-virus curbs were in place in Tokyo, Osaka and other areas until March. Despite a recent improvement in the infection situation, concerns have grown about the spread of the more transmissible BA.2 Omicron subvariant.
Hotel and restaurant operators were deeply pessimistic, with the index at minus 56, down 5 points from December, according to the survey.
Over the next three months, sentiment among manufacturers is expected to worsen further to 9 while that among nonmanufacturers will likely fall to 7, according to the Tankan survey.
Large companies, defined as those with 1 billion yen ($8.2 million) or more in capital, expect a 2.2 percent increase in capital spending for the current business year through next March. For the just-ended business year, it is expected to have increased 5.9 percent.
The yen tumbled to an over six-year low last week amid the prospect of diverging monetary policies between the BOJ and the U.S. Federal Reserve, which is expected to go ahead with multiple rate hikes this year.
Companies in the Tankan survey expect the dollar to average 111.93 yen, much lower than the 122 yen zone seen recently. The euro is projected at 128.18 yen for the current fiscal year.
The BOJ surveyed 9,362 companies, of which 99.1 percent responded between Feb. 24 and Thursday.