Japan economic outlook | Deloitte Insights #JapanFinance

Expectations of stronger rate cuts in the United States and more rate hikes in Japan caused the yen to appreciate in August 2024. By the end of August, the yen had appreciated to 144.6 against the US dollar—the strongest it had been since the first week of the year.¹² The yen continued to appreciate slightly in September: A stronger currency will lower the cost of imports, notably for food and energy. The import price index in August was up just 2.6% from a year ago, after rising by 10.8% in the previous month,¹³ signaling that imported inflation has responded quickly to the stronger yen.

Further appreciation of Japan’s currency will largely depend on policymaker decisions in both Japan and the United States. The Bank of Japan kept rates steady at its September meeting but has signaled a willingness to eventually raise rates to 1%, up from “around 0.25%.”¹⁴ The new leader of Japan’s ruling party, Shigeru Ishiba, is seen as an inflation hawk and supportive of additional interest rate increases. As a result, Japanese equity markets fell when trading resumed following his win.¹⁵ However, he is expected to maintain the Bank of Japan’s independence, which would prevent him from intervening in monetary policy. Plus, he has since stated that interest rates are not yet ready to rise further.¹⁶

At the same time, the US Federal Reserve cut rates by 50 basis points in September and signaled another 150 basis points of cuts by the end of 2025.¹⁷ A more dovish stance from the Bank of Japan or a more hawkish one from the Fed could cause the yen to depreciate again. A significant expansion of the US fiscal deficit following the election could cause the Fed to take a more hawkish stance than currently expected. Despite such risks, we expect the yen to gradually appreciate against the US dollar, which will support our view of a modest acceleration in consumer spending.

A stronger yen is also expected to help the government achieve its spending goals, especially for defense. The country’s defense ministry requested 8.54 trillion yen (or US$57 billion) for fiscal year 2025, which is up 10.6% from the budget submitted for the previous fiscal year.¹⁸ Japan is aiming to increase defense spending to 2% of GDP, now that it has adopted a new national security strategy that is no longer exclusively focused on self-defense.¹⁹ Because Japan will need to import defense-related goods from other countries, such as the United States, a stronger yen should make such expenditures more affordable. Japan’s defense spending will also need to be increasingly geared toward such equipment as an aging population limits growth of military personnel.

While a stronger yen is supporting consumer spending and domestic demand more generally, it is weighing on external demand. In August, the number of foreign visitors to Japan fell to its lowest level since February 2024 (figure 2).²⁰ Foreign visitors are a large source of services exports for Japan. Similarly, goods exports fell to their lowest level since March.²¹ Some of the weakness was due to ongoing challenges in the auto sector. After auto production mostly recovered from shutdowns during the spring, a larger swathe of automakers and vehicles were revealed to have had testing irregularities.²² Auto production slumped again in June and July and has yet to return to the level of output seen in December 2023. As a result, motor vehicle exports declined by double-digit rates to China, the European Union, and the United States.²³