Speech by Board Member KOEDA in Fukuoka (Economic Activity, Prices, and Monetary Policy in Japan)

M a y 2 1 , 202 6

B a n k o f Ja p a n

Speech at a Meeting with Local Leaders in Fukuoka

Member of the Policy Board

(English translation based on the Japanese original)

I. Current Situation and Outlook for Economic Activity and Prices

When considering the current situation and outlook for economic activity and prices, this time I believe it is necessary to address the geopolitical risks related to the situation in the Middle East, which materialized this spring. Please refer to the geopolitical risk index in the left panel of Chart 1.1Generated through text analysis of newspaper articles, this index has risen to a level comparable to its level during the Ukraine crisis in 2022, reflecting the risks surrounding the current situation in the Middle East.

In response to the situation in the Middle East, Dubai crude oil prices, i.e., the spot prices at which crude oil from the Middle East is actually traded, have risen more than they did during the Ukraine crisis, as shown in the right panel of Chart 1. Global food prices, also shown in the right panel of Chart 1, are currently relatively stable; however, they could be affected by factors such as a surge in the price of some fertilizers that are mainly produced in the Middle East.

Japan relies on overseas sources for energy and food, and being an island nation, most imports by volume depend on sea transport. For a country like Japan that is highly dependent on energy imports, the current situation in the Middle East may be interpreted as a negative supply shock accompanied by soaring crude oil prices, and it is natural to think that this shock will weaken economic activity while pushing up prices.

During the Ukraine crisis around spring 2022, there were unprecedented supply-side constraints on a global basis, coinciding with the post-pandemic reopening of economic activity in Europe and the United States, as well as China's zero-COVID policy. As a result, market factors -- specifically, soaring crude oil and food prices -- drove up import prices, leading to a deterioration in the terms of trade (left panel of Chart 2). Exchange rate factors also contributed to the significant increase in import prices, as the yen depreciated at that time (right panel of Chart 2 and left panel of Chart 10). Meanwhile, export prices increased in yen

1Caldara, Dario and Matteo Iacoviello (2022), "Measuring Geopolitical Risk," American Economic Review, April, 112(4), pp.1194-1225.

terms, reflecting the effects of the yen's depreciation, but this increase has not fully offset the effects of past deterioration in the terms of trade (right panel of Chart 2).

Against this recent background, I believe the Bank of Japan needs to assess how long the present situation in the Middle East will last, what kind of impact it will have on the global economy, to what extent external demand will weaken, and, under these circumstances, how Japan's net exports will change in light of current exchange rate levels. In doing so, the Bank should monitor not only the situation in the Middle East but also developments in global IT demand and the status of global supply chains. Strong global IT demand is reflected, for example, in the recent surge in copper prices (right panel of Chart 1). The Bank also needs to monitor how the rise in crude oil prices will affect Japan's economic activity and prices.

With these issues in mind, today I will explain my assessment of the current situation and outlook for economic activity and prices.

Let me begin with developments in overseas economies. The reference forecast released by the International Monetary Fund (IMF) in April 2026 assumes that the heightened risks stemming from the Middle East situation will persist until around the summer. In this forecast, the global economy is projected to grow moderately on the whole, despite being affected by the situation in the Middle East (left panel of Chart 3). That said, intensified supply-side constraints due to the prolonged Middle East situation may become a factor that significantly influences the outlook. The suppliers' delivery times Purchasing Managers' Index (PMI) in the right panel of Chart 3 suggests that the impact seems to be limited so far, compared with the time of the global supply-side constraints observed around 2022, although there are signs of delivery times becoming longer. Supply quantity constraints may intensify through the impact on supply chains, and therefore I remain alert to how this unfolds.

The outlook for overseas economies depends on to what extent the adverse economic shocks that could arise from the situation in the Middle East are offset by the robust global IT demand and fiscal policy in each jurisdiction. Specifically, it is important to assess where in the supply chain and to what extent supply-side constraints may emerge amid strong IT demand. It is

also necessary to take into account the possible effects of fiscal policies. The economic effects of increased defense spending, however, may not necessarily be significant, as the multiplier effects may vary depending on, for example, the degree of import inducement arising from increased spending.

Next, I would like to turn to Japan's economy.

With Japan possessing petroleum reserves, the situation in the Middle East is yet to be significantly reflected in recent hard data on components such as business fixed investment (Chart 4). Corporate profits have recently been at high levels (left panel of Chart 5). As can be seen from progress in wage revisions this spring, wage increases for 2026 also seem to be solid overall, including at small firms as defined by the number of union members (Chart 6). However, as shown in the diffusion index (DI) for business conditions in the Bank's March 2026 Tankan (Short-Term Economic Survey of Enterprises in Japan), firms are taking a cautious view on future business conditions (right panel of Chart 5).

Regarding exports, the share of Japan's exports to the Middle East is not so large for both goods and services overall, but the share of its transportation machinery exports is relatively high. It is necessary to monitor not only developments in exports to the Middle East but also in exports to other economies that are highly dependent on energy resources from the Middle East. The NIEs and ASEAN economies, in particular, are examples of such energy-dependent economies, including in terms of crude oil and liquefied natural gas (LNG). Japan's IT-related exports to these economies have been increasing in recent years, as these economies have expanded their IT-related exports to the United States, which is a key driver of global IT investment. With respect to services exports, which account for about a quarter of Japan's total exports, attention needs to be paid to developments in inbound tourism consumption. Although the number of visitors to Japan from China has declined markedly since autumn 2025, the impact on inbound tourism consumption as a whole seems to have been limited so far, owing to a significant increase in the number of visitors from other regions.

Turning to household spending, the higher inflation expected as a result of the recent situation in the Middle East may reduce households' purchasing power. It is therefore important to examine to what extent this could weaken domestic consumption. Consumer confidence for March 2026 onward has deteriorated significantly amid an already weakening trend in consumption of nondurable goods, including food (Chart 7). That said, wage increases have taken hold and scheduled cash earnings have been rising stably, as shown in Chart 9, reflecting firms' strong sense of labor shortage under tight labor market conditions overall (right panel of Chart 8). It is necessary to continue monitoring the sustainability of the interaction of wages and prices, i.e., the situation in which a moderate rise in prices and wages, accompanied by a rise in labor productivity, results in an increase in real wages and consumption.

The situation in the Middle East seems yet to have been fully reflected in recent hard data. Meanwhile, the output gap has recently been positive (left panel of Chart 8). The Bank's view in the April 2026 Outlook for Economic Activity and Prices (Outlook Report) is that the economy "has recovered moderately, although some weakness has been seen in part, partly due to the impact of the situation in the Middle East." I will discuss the outlook and the risk balance for economic activity later.

Next, I would like to discuss prices.

Chart 10 suggests that the producer price index (PPI) has been influenced by developments in import prices. The year-on-year rate of increase in import prices has widened significantly for April 2026, due to developments in commodity prices and foreign exchange rates, and that in the PPI has also increased to around 5 percent, driven by energy-related factors. On this point, the final demand-intermediate demand (FD-ID) price indices, which can represent business-to-business (B2B) prices, or price pass-through between firms, indicate that energy prices were passed on swiftly at the upstream stage of the production process during the Ukraine crisis in 2022 (Chart 11). The rise in energy prices is expected to be transmitted downstream.