Japanese Economy: Conditions for a December Rate Hike Are Largely in Place

■ Corporate profits and equipment investment remain strong, with limited negative effects from US tariff increases. 

■ Talks between the Bank of Japan and the government have advanced, laying the groundwork for a December rate hike, but further increases still face resistance. 
 
   The corporate data for July-September, released on December 1st, showed that nominal equipment investment (including software, down 1.4% quarter-on-quarter and up 2.9% year-on-year) declined for the first time in six quarters, mainly due to a decline in manufacturing investment (down 5.1% quarter-on-quarter and up 1.4% year-on-year). This survey is an important basis for calculating equipment investment in GDP statistics. Based on these results, the actual equipment investment in the second preliminary GDP report for July-September, to be released on December 8th, is expected to be revised downward from the initial 1.0% quarter-on-quarter growth. However, non-manufacturing equipment investment (up 0.7% quarter-on-quarter and 3.9% year-on-year) remained solid. Meanwhile, investments to save labor and address AI-related demand are supporting overall equipment investment. 
 
   The resilience of equipment investment is linked to strong corporate profits. Both manufacturing (up 5.9% quarter-on-quarter and 23.4% year-on-year) and non-manufacturing (up 2.1% quarter-on-quarter and 17.6% year-on-year) profits increased, marking two consecutive quarters of growth. Despite declines in sectors like transportation machinery, overall profit levels hit record highs. According to Reuters' Tankan survey (November Business Climate Index DI: Manufacturing 17, up 9 points from last month; non-manufacturing 27, unchanged), business sentiment has continued to improve since the summer, mainly in manufacturing, with no signs of negative effects from US tariff uncertainty on overall activity. Additionally, the labor force distribution rate for July-September, based on corporate data, averaged 55% over the past four quarters, remaining nearly flat since early 2024. Looking longer-term, Japan's labor force distribution rate has been declining since 2010 and is currently below the roughly 70% level of that time. From a macroeconomic point of view, companies still have room to increase wages relative to profits. 

 
   In his speech on the 1st, Bank of Japan Governor Kazuo Ueda stated, "At the next meeting, we will make an appropriate judgment on whether or not to raise interest rates." This suggests progress in talks with the Takashi City government, considered to favor easing policy, and a possible consensus on interest rate hikes during the BOJ's December meeting. Given the persistent rise in prices, the conditions for further rate hikes are present in terms of economic fundamentals, as reflected in most policymakers' speeches and the main points from the October 29th and 30th meetings. The market will now focus on how much room the Bank of Japan still has for hikes, but since the BOJ aims for gradual increases, the government might try to limit the pace of future rate hikes.