Sentiment among major Japanese manufacturers unexpectedly worsened for the third straight quarter in the Bank of Japan's September survey released Monday, as higher raw material costs, magnified by a sharp drop in the yen, threatened to squeeze their profits despite an easing of COVID-19 supply bottlenecks.

The reading of the key index measuring confidence among companies such as those in the auto and electronics sectors fell to 8 in September from 9 three months earlier, according to the BOJ's Tankan survey. The average market forecast was for an improvement to 11 in a Kyodo News survey.

The mood among nonmanufacturers, meanwhile, improved slightly to 14 from 13 in the previous survey, up for the second straight quarter, as economic activity picked up pace with the removal of anti-coronavirus curbs.

The Tankan index represents the percentage of companies reporting favorable conditions minus the percentage reporting unfavorable ones.

As Russia's war against Ukraine drags on, higher energy and raw material costs have cast a pall over the economic outlook, prompting companies to pass on increased costs to protect their profits.

The yen has plunged against the U.S. dollar, reflecting the widening interest rate differential between Japan and the United States as inflation has been accelerating at different speeds.

"On balance, the data show the economy lacks vigor," said Shinichiro Kobayashi, a senior economist at Mitsubishi UFJ Research and Consulting Co.

"The economy has emerged from the COVID-19 fallout, but there are negative factors weighing on sentiment such as rising prices, monetary tightening and the prospect of a global economic slowdown," Kobayashi said.

Companies in the survey expect the dollar to trade at 125.71 yen on average in the current business year to March, up sharply from 118.96 yen in the previous survey.

Japan carried out a currency intervention in September to arrest the yen's rapid depreciation and the dollar was trading near the 145 yen line on Monday.

"The weaker yen is positive for automakers and machinery makers but there are many firms that have not been able to pass on higher costs, driven by the weaker yen," Kobayashi said.

The BOJ has maintained its ultralow rate policy to support the economy, still in the midst of recovering from the COVID-19 malaise, but its persistently dovish stance has led to a relentless drop in the yen, boosting import costs for the resource-poor nation.

Reflecting the current cost-driven inflation, companies in the survey expect a 2 percent year-on-year rise in prices five years later, hitting the BOJ's target, for the first time.

The Japanese central bank, however, expects the core consumer price index, excluding volatile fresh food items, to undershoot its target in both fiscal 2023 and 2024.

"It's worth noting that the price outlook reached 2 percent. What is more important is whether inflation expectations will continue to improve from the next fiscal year onward as robust wage growth is a prerequisite for a policy change (by the BOJ)," said Toru Suehiro, a senior economist at Daiwa Securities.

The data showed major companies were increasingly raising retail prices to reflect higher input costs, though many companies were still struggling to pass on such costs.

The index of sales prices in the manufacturing sector rose to 36, its highest reading since 1980, while its equivalent figure for input costs stood at 65, also the highest level since the same year.

The easing of supply bottlenecks caused by the pandemic has helped automakers, which were forced to curb output. But sentiment among sectors relying on imports of food, lumber, paper and nonferrous metals, worsened.

The hotel and restaurant industry was less pessimistic than before, with sentiment improving to minus 28, but it still lagged behind other nonmanufacturing sectors.

While Japan's economy likely grew in the July-September quarter, economists expect it did so at a slower pace than the annualized real rate of 3.5 percent in April-June.

Sentiment among big manufacturers is expected to improve slightly to 9 over the coming months and the mood among nonmanufacturers will likely drop to 11, the data showed, weighed down by higher input costs.

Japanese companies, both manufacturers and nonmanufacturers, are planning to step up capital investment in fiscal 2022 by 16.4 percent from a year earlier, revised upward from 14.1 percent in the previous survey. The increase was the largest on record at the end of September.

The BOJ surveyed 9,268 companies, of which 99.5 percent responded between Aug. 29 and Friday.


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