Japan's Business Confidence Rises Despite Iran War Uncertainty, BOJ Rate Hike Expected

Japan's large manufacturers reported improved business sentiment in the three months to March, according to the Bank of Japan's closely watched Tankan survey released Wednesday. The headline index for big manufacturers climbed to +17, up from +16 in December, beating the median market forecast of +16. Large non-manufacturers held steady at +36, surpassing expectations of +33.

Despite the positive reading, companies anticipate conditions will deteriorate over the next quarter as soaring fuel costs and global supply disruptions tied to the ongoing Iran conflict weigh on the broader economic outlook. Marcel Thieliant of Capital Economics noted that firms appear to be absorbing the energy shock, which may give the BOJ confidence to raise interest rates at its upcoming April meeting.

The survey was conducted between February 26 and March 31, with around 70% of respondents submitting answers by March 12 — nearly two weeks after U.S.-Israel strikes on Iran began on February 28. A BOJ official acknowledged the results may not fully reflect the conflict's economic impact, noting that while AI chip demand and easing U.S. trade policy uncertainty boosted morale, labor shortages and rising energy costs remained persistent drags.

Large firms projected capital expenditure growth of 3.3% in fiscal 2026, slightly above market forecasts. Inflation expectations also rose, with companies projecting a 2.6% inflation rate one year out — a record high — signaling that price pressures remain deeply embedded in Japan's corporate planning.

The Iran conflict has effectively disrupted the Strait of Hormuz, a critical chokepoint handling roughly a fifth of global oil and gas flows, pushing crude prices higher. For Japan, which imports nearly all of its fuel, this presents a dual threat: accelerating inflation while simultaneously dampening economic activity.

Markets currently price in approximately a 70% probability of a BOJ rate hike in April, building on December's move to a 30-year high of 0.75%.