• Reuters, Bloomberg

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Japan’s service-sector mood improved to a two-year high but the recovery among manufacturers stalled, a closely watched central bank survey showed, a sign rising raw material costs was weighing on the economy’s recovery from the pandemic.

Big firms expect conditions to worsen ahead as high fuel prices and a weak yen push up import costs, reinforcing market expectations Japan will maintain massive fiscal and monetary support to underpin a fragile economy.

“Nonmanufacturers’ sentiment got a boost from the end to pandemic curbs, while supply constraints hit manufacturers,” said Toru Suehiro, an analyst at Daiwa Securities.

“Overall, business confidence lacks strength with both manufacturers and nonmanufacturers expecting conditions to worsen,” he said.

The headline index gauging big manufacturers’ sentiment stood at plus 18 in the final quarter of 2021, unchanged from the previous quarter and below a market forecast for plus 19, the Bank of Japan’s tankan survey showed on Monday.

Positive figures mean optimists still outnumbered pessimists, but the survey likely underrepresents concerns over the omicron variant as close to 80% of companies had responded by Nov. 29, only days after omicron was flagged as a variant of concern.

Rising costs and auto output disruptions hit industries such as nonferrous metals, chemicals and machinery, it showed.

By contrast, big nonmanufacturers’ sentiment improved for the sixth straight quarter at plus 9, up from plus 2 in September and exceeding market forecasts of plus 6.

The index hit the highest level since December 2019, as the Sept. 30 lifting of state of emergency curbs to combat the COVID-19 pandemic boosted morale among retailers.

But rising raw material costs added to uncertainty by squeezing profits of firms just emerging from the pandemic’s hit.

An index gauging big manufacturers’ output prices rose to levels last seen in 1980, though the gauge for input prices was also at its highest since 2008, the survey showed, a sign firms may struggle to hike prices as much as needed to cover costs.

Companies expect inflation to hit 1.1% a year from now, the tankan showed, marking the highest level since September 2015.

Despite the murky outlook, companies plan to increase hiring and capital expenditure to deal with a chronic labor shortage.

Big firms plan to increase capital spending by 9.3% in the year ending in March 2022, less than market forecasts for a 9.8% gain but rebounding from an 8.3% drop in the previous year.

Japan has lagged other countries in staging a strong rebound from last year’s pandemic hit, shrinking an annualized 3.6% in July-September due to weak consumption and output hit by a spike in infections and supply constraints.

While analysts expect growth to bounce back in the final quarter of this year, some warn the emergence of omicron clouds the outlook and may keep the recovery feeble next year.

The BOJ will look closely at the tankan to get a read on credit conditions for businesses as they decide the fate of a special COVID-19 funding program as early as this week’s meeting ending on Friday.

The survey showed the financial position of large enterprises holding at 16, with a small improvement for medium-sized enterprises and a slight worsening for small enterprises.

“It will probably be hard for the BOJ to completely finish the whole COVID funding program, but it’s possible that they start lowering the purchase of corporate bonds and commercial paper as today’s tankan continues to show funding conditions remain favorable,” said economist Kazuma Maeda at Barclays PLC.

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