PUBLISHED June 28, 2026
Growth Forecast Cut in Response to the Middle East Situation
According to economists Keiji Kanda, Hirohito Hatanaka, Kanako Nakamura and Kachidoki Yokota at the Daiwa Institute of Research, in light of the announcement of the January-March 2026 GDP first preliminary results, the institute has revised its economic outlook, now projecting Japan’s real GDP growth at +0.6% in FY2026 and +0.8% in FY2027. In response to the situation in the Middle East, Daiwa revised its growth forecast downward, particularly for FY2026, compared to its previous announcement on March 10 — a clear signal that the crisis has proven more disruptive to the Japanese economy than initial assessments suggested.
The Main Scenario: A Resolution and Gradual Oil Price Decline
Daiwa’s main scenario assumes that the situation in the Middle East will come to an end in a relatively short period of time, with a downward trend in the price of crude oil and a recovery in supply continuing thereafter. This baseline mirrors the assumptions used by other Japanese forecasters, including the Daiichi Life Research Institute, which similarly expects Strait of Hormuz concerns to ease by summer 2026 and oil prices to gradually normalize over the following year, even if they remain above pre-crisis levels for some time.
A Renewed Oil Shock Could Cut Growth Nearly in Half
Things remain highly uncertain, however. If a shortage of crude oil and other supplies occurs in Asia, including Japan, and crude oil prices rise again from the fourth quarter of 2026 to the first quarter of 2027, Daiwa estimates that Japan’s real GDP growth rate for FY2026 would fall by 0.4 percentage points — a scenario that would reduce growth to roughly 0.2%, effectively wiping out most of the modest expansion currently projected for the year.
Due to rising inflationary pressures stemming from the situation in the Middle East, core CPI is projected to rise by +2.6% year-on-year in FY2026 and +2.2% in FY2027. This places Daiwa’s inflation forecast somewhat above the Daiichi Life Research Institute’s parallel estimate of +2.4% for FY2026, reflecting differing assumptions about the pace of pass-through from elevated energy and import costs into broader consumer prices.
Due to rising inflationary pressures stemming from the situation in the Middle East, core CPI is projected to rise by +2.6% year-on-year in FY2026 and +2.2% in FY2027. This places Daiwa’s inflation forecast somewhat above the Daiichi Life Research Institute’s parallel estimate of +2.4% for FY2026, reflecting differing assumptions about the pace of pass-through from elevated energy and import costs into broader consumer prices.
Daiwa anticipated that the Bank of Japan would raise short-term interest rates to 1.00% as early as June 2026, and then raise them by a further 0.25 percentage points approximately once every six months thereafter — a forecast that has since been borne out. The central bank delivered exactly that move on June 16, lifting its policy rate to 1%, its highest level since 1995, in what analysts widely described as a “done deal” given that Japan’s wholesale inflation had hit 6.3% in May, the highest reading since March 2023, while a weak yen trading above ¥160 to the dollar added further pressure for tighter policy.
The Bank’s June Summary of Opinions indicated broad support among policymakers for continuing rate hikes, citing underlying inflation moving closer to the 2% target while financial conditions remain accommodative. Board member Naoki Tamura has been particularly vocal, arguing the policy rate should gradually move toward a neutral level of around 2% — meaning the current 1% level still represents a relatively early stage in a tightening cycle the Bank appears determined to continue, barring a sharp deterioration in growth.
Deputy Governor Ryozo Himino has explicitly tied the rate decision to the risk that underlying inflation may deviate upward from the Bank’s target, noting that wholesale inflation has been accelerating as firms pass on higher costs stemming from the Middle East conflict. The combination of imported energy costs and a weak currency creates a particularly difficult policy environment: a weaker yen boosts the competitiveness of Japanese exports, but simultaneously increases imported inflation and pressures government finances as Tokyo seeks to cushion households from rising prices through subsidies — exactly the kind of bind that has pushed the BOJ toward a steady, if cautious, path of policy normalization even amid acknowledged geopolitical uncertainty.
Daiwa anticipated that the Bank of Japan would raise short-term interest rates to 1.00% as early as June 2026, and then raise them by a further 0.25 percentage points approximately once every six months thereafter — a forecast that has since been borne out. The central bank delivered exactly that move on June 16, lifting its policy rate to 1%, its highest level since 1995, in what analysts widely described as a “done deal” given that Japan’s wholesale inflation had hit 6.3% in May, the highest reading since March 2023, while a weak yen trading above ¥160 to the dollar added further pressure for tighter policy.
The Bank’s June Summary of Opinions indicated broad support among policymakers for continuing rate hikes, citing underlying inflation moving closer to the 2% target while financial conditions remain accommodative. Board member Naoki Tamura has been particularly vocal, arguing the policy rate should gradually move toward a neutral level of around 2% — meaning the current 1% level still represents a relatively early stage in a tightening cycle the Bank appears determined to continue, barring a sharp deterioration in growth.
Deputy Governor Ryozo Himino has explicitly tied the rate decision to the risk that underlying inflation may deviate upward from the Bank’s target, noting that wholesale inflation has been accelerating as firms pass on higher costs stemming from the Middle East conflict. The combination of imported energy costs and a weak currency creates a particularly difficult policy environment: a weaker yen boosts the competitiveness of Japanese exports, but simultaneously increases imported inflation and pressures government finances as Tokyo seeks to cushion households from rising prices through subsidies — exactly the kind of bind that has pushed the BOJ toward a steady, if cautious, path of policy normalization even amid acknowledged geopolitical uncertainty.
