Business confidence among major Japanese companies continued to improve in September despite concern about slowing global growth, with nonmanufacturers the most optimistic in over three decades as COVID-related bottlenecks eased, the Bank of Japan said Monday.

Sentiment among manufacturers improved for the second straight quarter to 9 in September from 5 three months earlier, buoyed by confidence among automakers recovering to a level last seen before the pandemic.

The index for large nonmanufacturers, including the service sector, rose to 27, the highest since November 1991, from 23, marking the sixth straight quarter of improvement.

The readings were stronger than the average market forecasts of 6 for manufacturers and 24 for nonmanufacturers in a Kyodo News survey.

Parts shortages that had plagued automakers continued to ease, supporting exports to key markets such as the United States even amid concern that aggressive interest rate hikes by the likes of the U.S. Federal Reserve and the European Central Bank would slow global growth.

Service providers were supported by demand from holidaymakers during the summer and a revival of inbound tourism following Japan's lifting of strict COVID-era travel restrictions.

Sentiment among hotel and restaurant operators rose to 44, the highest since comparable data became available in 2004.

The Nakamise shopping street running to Senso-ji temple in Tokyo's Asakusa district is crowded with foreign tourists on July 19, 2023. Government data shows foreign arrivals to Japan from January to June topped 10 million for the first time since the same period in 2019 before the coronavirus pandemic. (Kyodo) ==Kyodo

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

"Concerns about overseas economies, such as China, do exist. But the recovery in the auto sector was clear in the survey. We do not expect to see demand (from China) tumble and corporate earnings severely dented," said Yoshimasa Maruyama, chief economist at SMBC Nikko Securities.

"Regarding the nonmanufacturing sector, it's hard to expect sentiment to improve sharply from here. That said, the normalization of economic activity and accumulated household savings will support demand for services," he added.

Japanese companies, both manufacturers and nonmanufacturers, have bullish investment plans, with a 13.0 percent increase in capital spending expected in the current fiscal year to next March.

Strong domestic demand is critical for the economy to maintain its recent recovery trend, mostly led by robust exports, economists say.

Maruyama said companies have a strong appetite to invest in labor-saving technology and AI among other areas on the back of strong corporate earnings. "The capex plans may be trimmed going forward...but we don't need to be pessimistic," he added.

With a weaker-than-expected recovery from its "zero-COVID" policy as well as its real estate woes, a slowdown in China, a key trading partner for Japan, has emerged as a downside risk to the world's third-largest economy.

Looking ahead, manufacturers' confidence is expected to improve slightly to 10 from 9, according to the BOJ. Sentiment among nonmanufacturers is forecast to worsen to 21 from 27.

As Japan's economy expanded for the third straight quarter in April to June, labor shortages have become more evident, particularly among service providers.

The employment index fell to minus 36 for the nonmanufacturing sector, the lowest since the BOJ began compiling relevant data in 1992. A negative reading indicates labor is in short supply.

Rising energy and raw material costs have prompted companies to raise prices, keeping Japan's inflation rate above the BOJ's 2 percent target for well over a year.

Still, small and medium-sized firms have lagged behind bigger companies in passing on higher costs, according to the latest BOJ survey.

While the BOJ expects inflation to slow and its inflation target not to be stably and sustainably achieved in the near term, the Tankan survey painted a different picture.

Japanese companies expect inflation to remain above 2 percent a year, three years and five years from now.

"Longer-term inflation expectations did not rise (from the previous survey) and business sentiment did not change significantly. This means the BOJ's stance on monetary policy will remain the same," said Toru Suehiro, chief economist at Daiwa Securities.

The BOJ is scheduled to hold a policy-setting meeting in late October, with the Tankan survey among the materials to be used in assessing the state of the economy.

The prospect of the BOJ persisting with ultralow rates is behind the yen's weakness against the U.S. dollar and euro.

The assumed dollar-yen exchange rate was lifted to 135.75 yen for fiscal 2023 from 132.43 yen, still far from its current levels near 150 yen amid caution about another round of intervention by Japanese authorities.

A weak yen inflates import costs for resource-scarce Japan while boosting the value of profits made overseas by exporters.

The BOJ surveyed 9,111 companies, of which 99.4 percent responded between Aug. 29 and Friday.


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