Factory Activity Declines in Japan, but Services Sector Strengthens

Preliminary business surveys released on Friday revealed that Japan's factory activity has plunged to a 10-month low due to sluggish demand. However, the service sector continues to expand, reinforcing its critical role in anchoring economic growth amidst the struggles faced by the manufacturing sector.

Manufacturing Sector Performance

The au Jibun Bank flash Japan manufacturing purchasing managers' index (PMI) dropped from 49.6 in December to 48.8 in January. This decline marks the index's eighth consecutive month below the 50.0 threshold, indicating persistent contraction in the manufacturing sector.

Subdued demand from both domestic and overseas markets has been weighing heavily on Japan's manufacturing industry. Trade data for December showed a decline in exports to Japan's top trading partners, with decreases of 3% to China and 2.1% to the United States.

The PMI survey reflected these challenges, with manufacturing output declining at its steepest pace since April 2022, and new order inflows falling to their slowest rate in six months.

Service Sector Growth

In contrast to the manufacturing sector, Japan's service industry continues to strengthen. The au Jibun Bank flash services PMI rose from 50.9 in December to 52.7 in January, driven by an increase in new businesses.

While input costs escalated at their fastest rate since August 2022 and new export businesses expanded for the first time since September, price-charged inflation and business sentiment remained largely unchanged.

Economic Outlook

Despite the weakness in manufacturing, the Bank of Japan is expected to raise interest rates from 0.25% to 0.50% on Friday. Analysts cite strong domestic wage growth and inflationary pressures as supporting the case for a rate hike.

The BOJ has indicated that wage hikes are spreading across firms of all sizes and sectors, creating conditions conducive to a near-term rate increase.

The au Jibun Bank flash Japan composite PMI, which encompasses both manufacturing and service sector activity, rose marginally from 50.5 in December to 51.1 in January. This suggests that the overall economic landscape remains somewhat positive despite the manufacturing sector's challenges.