Japan Services Growth Hits Five-Month High on Domestic Demand

Japan’s services PMI climbed to 52.5 in August as stronger domestic demand lifted business activity, while persistent inflationary pressures kept expectations of another BOJ rate hike alive.

Japan’s services sector expanded at its fastest pace in five months in August, supported by stronger domestic demand and increased new business, according to the latest S&P Global survey.

The final Japan Services Purchasing Managers’ Index (PMI) rose to 52.5 in August from 51.2 in July, remaining above the 50-point threshold that separates expansion from contraction.

The data point to improving momentum in Japan’s domestic economy, although weak overseas demand and elevated input costs continue to pose challenges for businesses.

Services Activity Accelerates

The August increase marked a significant improvement in Japan’s services activity after the sector recorded slower growth in July.

Business activity and new orders both strengthened during the month, with companies reporting firmer underlying demand from domestic customers.

Annabel Fiddes, Economics Associate Director at S&P Global Market Intelligence, said the latest figures indicated that growth momentum across Japan’s services economy had picked up.

The improvement comes as Japan's economy continues to navigate higher prices, changing consumer behaviour and expectations surrounding monetary policy.

New Orders Rise Again

New business increased for the 26th consecutive month, extending a lengthy period of growth.

The pace of new-order growth accelerated compared with July, suggesting that domestic customers remained an important source of support for service-sector companies.

However, the picture was considerably weaker in international markets.

New export business contracted for a fifth consecutive month, with the decline accelerating to its sharpest level since November 2020.

The divergence highlights the importance of domestic consumption to Japan's current services-sector performance.

Export Demand Remains Weak

Weak export demand remains a concern for Japanese service providers with international exposure.

While domestic customers increased their spending, overseas business continued to decline. The latest contraction was the strongest in almost six years.

The weakness could reflect softer external demand and continuing uncertainty in global markets.

For Japan, a sustained recovery in domestic demand could partially offset weaker international activity, but businesses with significant overseas operations may continue to face pressure.

Hiring Continues Across Sector

Employment in Japan's services sector increased for the 12th consecutive month in August.

However, the pace of job creation slowed to its weakest level in a year.

The continued increase in employment suggests that companies remain willing to expand their workforce as business activity improves. But the moderation in hiring could indicate that businesses remain cautious about the strength and durability of the recovery.

Labour-market conditions will remain important for the broader Japanese economy, particularly as companies continue to deal with elevated operating costs.

Input Costs Stay Elevated

Cost pressures eased slightly in August but remained high.

Input-cost inflation fell to a four-month low, yet remained among the fastest rates recorded over the past three-and-a-half years.

Businesses continued passing higher costs on to customers. As a result, output charges increased at the second-highest rate on record.

Persistent price pressures could complicate the Bank of Japan's efforts to balance economic growth with inflation.

BOJ Rate Hike Expectations

The combination of stronger domestic demand and continued price pressures could strengthen expectations of another Bank of Japan (BOJ) interest-rate increase.

A sustained rise in service-sector prices would provide policymakers with further evidence that inflationary pressures are becoming embedded in the economy.

At the same time, the BOJ must consider weaker export demand and relatively subdued business confidence.

Although confidence improved from July, it remained modest compared with recent standards.

Composite PMI Strengthens

Japan's broader private-sector economy also gained momentum during August.

The Composite PMI, which combines manufacturing and services activity, increased to 53.5 from 52.7 in July.

That was the strongest rate of private-sector expansion in six months.

The improvement suggests that Japan's overall business activity strengthened during the month, with the services sector providing an important source of momentum.

However, elevated costs, weak foreign demand and cautious business sentiment remain risks to the outlook.

For the Bank of Japan, the latest figures present a mixed but broadly encouraging picture: domestic demand is strengthening and private-sector activity is expanding, while inflationary pressures remain high enough to keep the prospect of further monetary tightening in focus.