Editor's note: Tang Jie is a researcher at the Chinese Academy of International Trade and Economic Cooperation under the Chinese Ministry of Commerce. The article reflects the author's opinions and not necessarily the views of CGTN.

Entering the second half of 2026, the Japanese economy presents a complex picture of "persistent inflation, strong manufacturing, and weakening services." On Thursday, Japan's Ministry of Internal Affairs and Communications released the latest data, showing that the core consumer price index (CPI) for July was 102.1, a year-on-year increase of 1.8%, further widening from the 1.6% increase in June. This marks the 59th consecutive month of year-on-year increases in Japan's core CPI. Furthermore, the overall CPI reached 1.9%, the highest level this year.

The direct driver of this round of inflation is the shift in energy prices from a 0.4% year-on-year decrease in June to an increase in July, coupled with the depreciation of the yen amplifying import costs, resulting in a clear imported inflation characteristic. According to reports from the Bank of Japan, wage growth has been passed through to selling prices. Combined with rising crude‑oil prices and the recent depreciation of the yen, these factors have contributed to inflationary pressures. As crude‑oil prices decline, the inflation rate is expected to gradually fall toward 2%.

Regarding the PMI, the gap between the expansion rates of the manufacturing and service sectors is widening. The composite PMI in August was 53.4, remaining above the 50-point threshold separating expansion from contraction. The manufacturing PMI rose to 55.1, with new orders growing at their fastest pace since January 2018, driven by strong expansion in the export supply chain fueled by demand related to semiconductors and AI. The service sector PMI was 52.3, maintaining expansion but constrained by weak domestic consumption, resulting in weak momentum for new business and sluggish recovery in domestic demand. Economic growth remains highly dependent on external demand.

On the wage front, domestic demand-driven inflation, fueled by domestic wages, has not yet fully materialized. Following the success of Japan's 2026 annual spring wage-bargaining round, the average corporate salaries increased by 5.01%, maintaining a level above 5% for three consecutive years. However, the benefits of these salary increases were concentrated on formal employees of large corporations. The wage increase rate for unionized employees in small and medium-sized enterprises was 4.69%, lower than the overall level, and the benefits to informal workers were even more limited. Considering the inflation and the increased social security contributions, the real wages for residents improved too slightly, failing to translate into an expansion of household consumption effectively. Data shows that in the second quarter of 2026, Japanese personal consumption declined by 0.02% quarter-on-quarter, marking the first negative growth in eight quarters. Moreover, the corporate equipment investment declined by 1.2% quarter-on-quarter, marking two consecutive quarters of decline.

Regarding exchange rates and monetary policy, even though the Bank of Japan's policy rate has risen to 1.0%, the interest rate differential between the US and Japan continues to suppress the Japanese yen, making it difficult to completely eliminate imported inflationary pressures. In fact, from the end of July to August 18, the gains from the joint intervention in the exchange rate by the US and Japan were more than eroded in just over ten trading days. The Bank of Japan faces a dilemma: monetary policy needs to find a balance between curbing inflation and protecting growth—raising interest rates too quickly could stifle fragile domestic demand, while raising rates too slowly could allow the yen to depreciate and inflation to spiral out of control.

Multiple factors have led to some structural changes in the Japanese economy. While economic data appears relatively positive, with external demand and imported inflation providing a facade of a "weak recovery," the underlying domestic demand remains fragile. A persistent labor shortage is forcing companies to raise wages and invest in automation, and the reluctance of companies to raise prices during deflation is shifting; AI and the semiconductor supply chain are injecting new momentum into the manufacturing sector. However, significant challenges remain: inflation is susceptible to external factors such as oil prices and exchange rates; income inequality constrains the release of domestic demand; global demand fluctuations directly impact manufacturing growth; and an aging population and high debt levels constitute long-term constraints.

Whether this structural change is "benign" is not yet entirely optimistic. Japan has met some of the necessary conditions to escape deflation, but not enough. Whether it can break free from the long-term predicament of low growth and deflation will depend on three key indicators -wage diffusion effect, real consumption momentum, and endogenous inflation.

(Cover via VCG)