Japanese Economy: Rising Oil Prices Increase Risks to Fiscal Expansion

■ Due to the potential for fiscal support measures to address rising oil prices, the likelihood of a sharp rise in inflation and a rapid economic slowdown in the short term is not high.  

■ However, implementing fiscal stimulus during an economic expansion period could increase inflationary pressures. The Bank of Japan is looking for an opportunity to raise interest rates. 
 
Although crude oil prices once surged and broke through $100 per barrel, the upward trend has now stabilized, but uncertainty remains as to whether the situation in the Middle East will truly ease. If crude oil prices continue to rise, the Japanese government may set a ceiling on retail prices through gasoline subsidies; the likelihood of a sharp rise in inflation and a resulting rapid economic downturn in the short term is not high. However, rising oil prices coupled with a depreciating yen, will weaken the effectiveness of the government's ongoing support policies for households (such as abolishing the old provisional gasoline tax rate). In this situation, political pressure surrounding issues such as the early implementation of food consumption tax cuts may further intensify in the National Assembly, thereby increasing the likelihood of fiscal expansion. Regarding monetary policy, a rate hike by the Bank of Japan in the April-June quarter remains the main scenario, but with rising exogenous uncertainty, the timing of the rate hike is also becoming more uncertain. 

 
Against this backdrop, the Japanese economy is showing robust growth above its potential growth rate. The second preliminary estimate of real GDP growth for the October-December quarter of last year, released on the 10th, was 1.3% annualized quarter-on-quarter, a significant upward revision from the 0.2% in the first preliminary estimate. This was mainly due to upward revisions to equipment investment (5.4% annualized) and personal consumption (1.1% annualized). A tight labor market and still-loose monetary policy appear to have boosted businesses' willingness to invest in equipment. Furthermore, improved income conditions amid continued price increases also supported consumption. 

 
This trend is expected to continue into early 2026. Monthly labor statistics for January showed that real wages (up 1.4% year-on-year) turned positive for the first time since December 2024. The main reason for the positive turn in real wages was that government price measures slowed consumer price increases, although nominal wages remained stable. Both total cash wages (up 3.0% year-on-year, common business benchmark: up 1.9% year-on-year) and wages equivalent to basic wages (up 3.0% year-on-year, common business benchmark: up 2.2% year-on-year) saw increased growth in January. Driven by improved real income, the real consumption activity index (adjusted for travel income and expenditure, up 0.4% month-on-month) remained robust in January, and consumer confidence (consumer attitude index: 40.0, up 2.1 points) also rose to its highest level since April 2019 in February. Furthermore, the labor-management negotiations in the spring of 2026 (the first round of statistics will be released on March 23) are expected to result in wage increases comparable to last year. The continued support for consumption from sustained wage growth and upward pressure on prices is likely to persist. With government fiscal support supporting domestic demand, the Japanese economy is expected to maintain a moderate expansion in 2026. However, implementing fiscal stimulus during an economic expansion phase could further increase inflationary pressures and also increase the risk of the Bank of Japan's interest rate hikes being "out of sync" (lagging). Against the backdrop of rising uncertainty, the Bank of Japan is expected to continue cautiously seeking opportunities to raise interest rates.