Japan business mood sours on higher costs, BOJ sticks to recovery view

Japanese manufacturers turned less positive about their business conditions in January, a survey showed on Wednesday, even as central bank governor Haruhiko Kuroda stressed the economy was on track for a recovery accompanied by rising inflation.

Along with the potential hit from a spike in COVID-19 cases led by the Omicron variant, companies complained of rising energy and raw material costs that were squeezing profits, the Reuters Tankan poll showed.

The survey highlights the dilemma Japan faces as a country that relies heavily on fuel and food imports, making its economy vulnerable to the type of cost-push inflation now under way.

While rising inflation is welcome progress for the Bank of Japan's effort to achieve its 2% price target, there is a risk the higher cost of living could cool consumption and discourage firms from raising prices - pushing Japan back into deflation.

In a speech to the BOJ's regional branch managers on Wednesday, Kuroda said consumer inflation was likely to gradually accelerate on rising energy costs and an expected increase in demand.

"Japan's economy is picking up as a trend, although it remains in a severe state due to the impact of the coronavirus pandemic," Kuroda said.

"The BOJ will scrutinise the pandemic's impact and won't hesitate to take additional easing steps as needed," he said, reiterating the central bank's resolve to focus on supporting a fragile economic recovery with massive monetary stimulus.

Japan's economy shrank in the third quarter of last year as supply constraints and curbs on activity to contain the pandemic hit factory output and consumption.

Analysts expect growth to have rebounded in October-December and the current quarter as output and consumption pick up, though a recent spike in Omicron infections clouds the outlook.

Sources have told Reuters the BOJ is expected to slightly raise its inflation forecast for the fiscal year beginning in April on rising energy costs, though the new projection will still be below its 2% target.

Japan has not been immune to the impact of global commodity inflation, with wholesale prices in November rising a record 9.0% from a year earlier.

But soft wage growth and consumption have prevented many firms from passing on rising costs to households, keeping core consumer inflation at a more modest 0.5% in November.

(Reporting by Daniel Leussink and Leika Kihara; Editing by Chang-Ran Kim and Jacqueline Wong)