The Japanese services sector gained momentum in August, registering its fastest pace of expansion in the last five months, primarily supported by a recovery in domestic demand. New data provides a positive signal regarding the development of the Japanese economy, although it leaves some uncertainties related to external trade, employment, and especially inflation.
The services PMI index compiled by S&P Global stood at 52.5 points in August, up from 51.2 in July. This marks the third consecutive month above the 50-point threshold, which separates growth from contraction in activity.
The improvement was accompanied by an increase in new orders. Surveyed companies reported a higher volume of work, new public sector-related projects, and an uptick in customer inquiries. New business has now recorded 26 consecutive months of growth and accelerated in August compared to the previous month.
The performance of domestic demand explains a large part of this development. However, the situation is different in international markets: new export orders declined for the fifth consecutive month, decreasing at the fastest pace since November 2020.
This discrepancy between the evolution of the domestic market and external sales introduces an important nuance to the positive results of the services sector. The Japanese economy demonstrates the capacity to sustain its activity through consumption and domestic demand while continuing to face a more complicated international context.
Employment grows, but loses momentum
The improvement in activity is not translating with the same intensity into the labor market. Employment in the services sector increased for the twelfth consecutive month, but it did so marginally and at the slowest pace in the past year.
Some companies expanded their workforce to respond to the increase in activity, while others chose not to replace certain voluntary departures. The backlog of work increased slightly, remaining near the minimum levels recorded in recent months.
This development is particularly significant in an economy like Japan’s, which has been facing the consequences of an aging population and a gradual reduction in its labor force for years. The availability of workers has become one of the structural factors influencing the country’s growth prospects.
Pressure on prices continues
The other major takeaway from the August PMI is the evolution of prices. While the growth of input costs moderated to its lowest level in four months, companies are still bearing considerable increases.
Part of these costs is being passed on to customers. Prices charged by services sector companies rose in August at the second-fastest rate since the statistical series began in late 2007.
This trend also extends to the overall economy. The composite PMI, which integrates manufacturing and services, rose from 52.7 points in July to 53.5 in August, its highest level in the past six months. Meanwhile, the selling prices of the composite indicator recorded the largest increase since the start of the series.
These data points could become particularly significant for the upcoming decisions of the Bank of Japan. An economy that continues to grow while companies pass on rising costs to consumers would strengthen arguments in favor of further normalizing monetary policy.
S&P Global believes that persistent cost pressures could lead to further increases in official inflation in the coming months and, combined with stronger economic activity, raise the likelihood of a new interest rate hike.
Japan thus faces the coming months with conflicting signals. The services sector, one of the main engines of its economy, is showing more dynamic activity and resilient domestic demand, while external trade is losing strength and inflationary pressures remain present. The evolution of these factors will determine the extent to which the recovery can be sustained and what the next move of the Bank of Japan will be.
