Recent sharp tensions in the Middle East have caused volatility in Japan's financial markets. According to reports, the United States and Iran announced a ceasefire and initiated two weeks of negotiations. Following this development, the Nikkei 225 Stock Average surged by over 2,600 points, reclaiming the 56,000 level, while international crude oil prices fell from around $117 per barrel to just above $90. This may offer Japan's economy a temporary respite under pressure. However, both the Japanese government and the international community remain cautious about whether lasting peace in the Middle East can be achieved. Stock and oil prices may continue to fluctuate, and the risk of stagflation in Japan's economy remains difficult to dispel.
Some analysts argue that military strikes by the U.S. and Israel against Iran have heightened Japan's stagflation risks. Although Japan's economy is in recovery—with a revised real GDP growth rate of 0.3% in the fourth quarter of last year, translating to an annualized rate of 1.3%, noticeably above its potential growth rate—the sudden shift in Middle East tensions has triggered a surge in international oil prices. Japan also faces the risk of crude supply disruptions due to potential obstructions in the Strait of Hormuz.
Amid concerns over oil supply shortages and rising crude prices, Japan has seen not only increases in gasoline prices but also early signs of price hikes in daily necessities. For example, polyethylene products such as food storage bags and garbage bags, as well as food containers made from expanded polystyrene, are becoming more expensive. These price increases are likely to push up the cost of processed foods in Japanese supermarkets. Additionally, ethylene oxide, widely used in sterilizing medical devices and pharmaceutical packaging, is also expected to rise, which will inevitably drive up medical expenses in Japan. Moreover, some Japanese companies, fearing potential raw material shortages, have already begun adjusting production volumes to avoid complete shutdowns. If this trend continues, Japan may face across-the-board price increases, making stagflation increasingly unavoidable.
Other analysts, however, contend that the Middle East situation is merely a short-term external factor with high uncertainty. They point to underlying structural issues within Japan's economy, noting that the country's industrial production index fell by 2.1% month-on-month in February, marking the first decline in three months. This suggests that Japan's economic fundamentals may be weaker than expected.
Whether due to short-term shocks or long-term structural factors, Japan's economy appears to be veering toward stagflation. More critically, the Japanese government's economic policies may not only fail to alleviate the situation but could exacerbate it. For instance, the government lacks concrete measures to address the crisis. Although it has prepared over ¥1 trillion in gasoline subsidies and announced plans to release oil reserves to ensure domestic supply, these are only temporary solutions. The subsidy fund is expected to last only a few months, and releasing reserves is a stopgap measure that does not address the root cause of potential crude shortages. Government statements indicate that the impact of oil supply constraints is already reflected in rising prices.
Rising prices may benefit the current administration, which seeks fiscal dividends, but they increase the living burden on citizens. Furthermore, Japan's nominal potential growth rate stands at 2.6%, and the gap between this rate and long-term returns has narrowed significantly compared to a decade ago. This suggests that fiscal dividends are diminishing while the cost of living is rising.
At the same time, the government's aggressive fiscal policy has contributed to yen depreciation, further driving up domestic prices. According to the latest data from the Bank for International Settlements, the yen's real effective exchange rate fell to 67.73 in January 2026 (base year 2020), the lowest level since Japan adopted a floating exchange rate system in 1973. The yen has lost about one-third of its value from its peak. A weaker yen and rising prices have become a heavy burden on Japanese households. Strengthening the yen could enhance Japan's purchasing power. Recently, the Bank of Japan has begun excluding certain special factors from its economic assessments, likely to create favorable conditions for interest rate hikes, which would help stabilize the yen. However, it remains uncertain whether the government, which holds differing views, will allow the central bank to raise rates in response to economic conditions.
On April 6, the yield on long-term Japanese government bonds rose to 2.43%, a record high since the start of the new century. This indicates that markets are growing concerned that the government's fiscal policies, including temporary measures such as consumption tax cuts aimed at maintaining public support, could worsen Japan's fiscal health. If this continues, the stock market may face increased risks.
After the passage of the FY2026 budget, the government has already begun considering a supplementary budget. Despite approving a record ¥122 trillion budget, current fiscal policies may still result in a ¥5 trillion revenue shortfall, making it difficult to achieve fiscal consolidation targets. If the government issues more bonds to fund its expansive fiscal policies, higher interest rates from the Bank of Japan would increase borrowing costs, creating a negative feedback loop for Japan's fiscal management.
Therefore, the greatest risk to Japan's economy may stem from governance issues arising from government policies. Ultimately, whether Japan can avoid stagflation may depend not only on government action but also on the resilience and vitality of Japanese corporations.
Comments