Structural transformation will keep Japan on solid ground in 2026

• The Bank of Japan raised interest rates by 25bps to 0.75% on 19 December 2025, reaffirming Japan’s continued shift away from decades of ultra-loose monetary policy.

• The rate hike is underpinned by a reflationary backdrop, with solid wage growth and strengthening consumption supported by Prime Minister Sanae Takaichi’s stimulus measures.

• Ongoing corporate reforms continue to underpin Japanese equity valuations, with sustained efforts to improve P/B ratios and ROE, alongside stricter listing standards to enhance the overall quality of listings on the Tokyo Stock Exchange.

• Earnings are expected to remain resilient, driven by growth in technology sectors as Japan advances its ambitions in semiconductor manufacturing and the domestic cloud ecosystem. Consumer and financial sectors are also poised to deliver steady growth.

• We project the Nikkei 225 Index to reach JPY 58,500 by FY2028 (year ended 31 March 2028), implying a 15.8% upside. Long-term valuation upgrades remain possible should capital efficiency continue to improve.

In a year largely defined by tariffs, AI, and geopolitical tensions, Japan may have flown under many investors’ radar. The Bank of Japan (BOJ) raised interest rates to 0.75% on 19 December 2025, reminding investors that the economy is continuing its shift away from decades of ultra-loose monetary policy and near-zero borrowing costs.

Investors who entered the market earlier have benefited from a strong rally, with equities gaining 22.8% year-to-date in SGD terms as of 29 December 2025. This robust performance has been underpinned by gradual and well-telegraphed monetary policy normalisation, ongoing corporate reforms aimed at unlocking shareholder value, and broad-based earnings growth. These same themes are likely to continue supporting Japanese equities through 2026.

Macroeconomic conditions remain supportive of continued monetary policy normalisation

The BOJ’s rate hike cycle is underpinned by a reflationary environment. Japan’s core CPI, the BOJ’s preferred measure of inflation, has remained above the 2% target since April 2022 (Figure 1).

Figure 1: Japan’s inflation remains firmly above the 2% target

Domestic consumption has provided some support to inflation, as reflected by core-core CPI remaining above 2% since September 2024. However, the recovery remains modest, with real consumption still lagging significantly behind nominal spending (Figure 2). Addressing cost pressures while lifting real consumption remains a key policy priority for Prime Minister Sanae Takaichi. The recently approved JPY 21.3 trillion stimulus package, including cash handouts, rice vouchers, and electricity bill subsidies, is well positioned to support higher household spending.

Figure 2: Consumption is improving, but real growth still trails nominal growth significantly

Another key indicator that Japan is moving toward sustainable inflation is improving wage dynamics. While real cash earnings remain in negative territory, the pace of decline has narrowed in 2H25 (Figure 3). More importantly, wage growth is expected to persist, as Rengo, Japan’s largest labour union, is once again pushing for wage increases of 5% or more in 2026. With ongoing wage growth, alongside consumption-supportive subsidies and government efforts to curb food inflation, Japan is likely to see positive real wage growth and stronger wage-driven consumption in 2026.

Figure 3: Wage growth continues to lag inflation

Japan’s economic growth has also been holding up well. In its latest quarterly Outlook for Economic Activity and Prices, the BOJ upwardly revised real GDP growth for 2025 from 0.6% to 0.7%, driven by stronger business investment and a rebound in exports. Looking ahead, the BOJ projects modest 0.7% YoY GDP growth for 2026, reflecting caution amid slowing global demand. However, reduced US tariff rates to 15% under recent trade deals and renewed stimulus measures Takaichi, aimed at supporting household consumption, could help mitigate downside risks to growth.

Japan’s macroeconomic environment points to a continued reflationary trend, supporting further monetary tightening. That said, the pace of rate hikes is likely to remain measured in 2026, as both real consumption and real wage growth still have room to improve.

Corporate reforms are fuelling Japanese equities’ appeal

Corporate reforms have been a key contributor to equity market growth. Since the Tokyo Stock Exchange (TSE) introduced measures to address low price-to-book (P/B) ratios in March 2023, companies have accelerated efforts to improve capital efficiency, earnings, and shareholder returns. As of 22 December 2025, the share of Nikkei 225 companies with P/B above one has risen from 45% in 2022 to 75%, with a weighted average P/B of 2.2X (Figure 4).

Figure 4: A growing share of Japanese companies is trading at higher P/B ratios

Return on equity (ROE), a key measure of how efficiently companies generate profit from investments, has also improved to 10.8% as of 22 December 2025, up from a pre-2023 average of 8.9%. While progress is evident, Japanese companies still lag other developed markets, with the S&P 500 and STOXX Europe 600 posting higher ROEs of 18.8% and 12.2% respectively.

Government initiatives continue to fuel reform and long-term improvements. In 2025, the Financial Services Agency revised the Stewardship Code to promote greater shareholder engagement through enhanced investor-company dialogue. The TSE also tightened listing criteria for the “Growth Market,” requiring companies listed for five or more years to meet a JPY 10 billion market capitalisation threshold by 1 March 2030. Firms failing to meet the target must present growth strategies to the TSE or face potential delisting.

Delistings are already on the rise, reflecting TSE’s focus on listing quality over quantity. In 2025, 124 companies were delisted, up from 94 in 2024. Rising costs of public listing and activist shareholder pressure are also driving management-led takeovers, particularly among smaller-cap companies that are often overlooked by global funds. With TSE’s transitional relief now ended, 2026 is expected to see further delistings. Importantly, this should be viewed as a positive rather than a concern. As weaker or less committed listings exit the market, the reforms incentivise the remaining companies to improve earnings quality, enhance liquidity, and raise their visibility in order to meet stricter listing standards. This, in turn, encourages better capital allocation and more shareholder-friendly behaviour.

Stimulus and reflation to drive robust earnings growth

Japanese companies delivered a strong rebound in FY2026 Q2 (July–September 2025), as tariff-related price distortions and export concerns eased. All sectors except energy and real estate posted positive earnings surprises (Figure 5). The top ten Nikkei 225 holdings collectively achieved an impressive 72% YoY earnings growth, with Advantest and SoftBank Group benefiting most from AI investments and the rapid expansion of high-performance computing (Table 1).

Figure 5: Most sectors delivered positive earnings surprises in FY2026 Q2

Table 1: The combined earnings of the Nikkei 225’s top 10 constituents increased by 72% YoY

Securities	Sector	2026Q2 EPS (JPY)	2025Q2 EPS (JPY)	Growth
Advantest Corp	Information Technology	109	62	77%
SoftBank Group Corp	Communication Services	1,757	808	118%
Fast Retailing Co Ltd	Consumer Discretionary	306	193	59%
Tokyo Electron Ltd	Information Technology	270	255	6%
TDK Corp	Information Technology	37	24	52%
KDDI Corp	Communication Services	54	43	26%
Konami Group Corp	Communication Services	197	127	55%
FANUC Corp	Industrials	45	44	3%
Shin-Etsu Chemical Co Ltd	Materials	70	76	-7%
Recruit Holdings Co Ltd	Industrials	89	77	16%
Source: Bloomberg Finance L.P., iFAST Compilations Data as of 30 Sept 2025.

Looking ahead, sectors such as communication services and information technology are set to gain from Prime Minister Takaichi’s technological nationalism agenda. Japan’s efforts to revive domestic semiconductor manufacturing, including its ambition to produce 2 nm chips, are expected to continue supporting Rapidus, including SoftBank and NTT, and other players in the semiconductor supply chain such as Tokyo Electron and Advantest. Government initiatives to build a domestic cloud ecosystem and data management platforms should also benefit cloud service providers, telecoms, and cybersecurity software firms.

Strong wage growth, combined with new stimulus packages should contain price pressures and boost consumption. Consumer staples are likely to be major beneficiaries, with brands such as Sapporo and Japan Tobacco recently upgrading full-year earnings forecasts on stronger domestic sales. Consumer discretionary, by contrast, may see more modest growth, as automakers, still heavily reliant on the US market, absorb higher costs to maintain market share, which squeezes profit margins.

The ongoing rate-hiking environment is also expected to support the financial sector, allowing banks to capture wider interest margins. Japan’s largest banks are already raising annual profit forecasts and expanding share buyback programs after strong Q2 results. Japan’s three largest banks have all upgraded their FY2026 earnings guidance. MUFG and SMFG have raised their earnings targets by around 5% and 15%, respectively, while Mizuho has upgraded its earnings forecast twice during the current financial year, resulting in a target that is now approximately 11% higher than its initial projection.

Figure 6: FY2026 earnings projections for the Nikkei 225 Index

The Japanese yen is expected to find modest support in 2026

The Japanese yen continued to weaken despite a 25bps rate hike in December, as JPY/USD movements diverged from narrowing rate differentials (Figure 7). The pressure likely stemmed from a widely expected rate hike size, BOJ Governor Kazuo Ueda’s cautious post-meeting commentary, and fiscal concerns tied to large budget outlays under the new Prime Minister.

Looking ahead to 2026, the yen is expected to find modest support. Persistent inflation and further BOJ tightening, coupled with stimulus measures boosting consumption, could strengthen the currency. A potential US rate cut would also narrow the interest rate spread, benefiting the yen. Finance Minister Satsuki Katayama has noted Japan has sufficient capacity to intervene in the currency market if excessive weakening occurs. Overall, the JPY is likely to maintain a slight upward bias in 2026.

Figure 7: The JPY/USD exchange rate decoupled from interest rate spreads

Japan’s appealing valuations boost its investment case

The Nikkei 225 is currently trading at a forward P/E of 20.2X, slightly below its long-term average of 20.5X (Figure 8). Strong earnings growth prospects, combined with recent share price pullbacks due to global technology selloffs and escalating diplomatic tensions with China, have created an attractive entry point.

While Japan-China tensions are unlikely to be resolved soon, Japan is expected to mitigate economic losses from tourism through stimulus measures and ensure supply chain stability via its “China+1” strategy. In the near term, volatility and price pressure may persist, but tensions are likely to be contained, as both countries have limited incentives to escalate further.

Based on a fair P/E of 20X, the Nikkei 225 is projected to reach JPY 58,500 by FY2028 (year ended 31 March 2028), representing an 15.8% upside. Near-term gains are supported by the resilience of Japan’s economy and earnings growth. As corporate reforms continue, metrics like ROE are expected to rise further, reflecting improved capital efficiency and profitability, paving the way for long-term valuation upgrades. Therefore, Japan’s structural reforms present a compelling long-term investment case, and we maintain a constructive 3.5-star ‘Attractive’ rating for the market.

We recommend investors maintain exposure to Japanese equities. One option is the Eastspring Investments - Japan Dynamic AS SGD, as its fundamental and value-biased approach has a strong track record in identifying mispriced stocks and capturing alpha. With our expectation of a slightly stronger yen, the unhedged share class offers potential gains from both share price appreciation and currency movements. For a lower-cost alternative, investors may consider the Xtrackers Nikkei 225 UCITS ETF 1D (LSE: XDJP), which comes with a low expense ratio of 0.09%.

Figure 8: The Nikkei 225 Index is currently trading slightly below its 10-year average

Table 2: Projections for the Nikkei 225 Index

	FY2025	FY2026	FY2027	FY2028
PE Ratio (X)	27.9	22.4	19.6	17.3
Expected Earnings Growth	24.5%	24.5%	14.4%	13.4%
Earnings Per Share (EPS)	1,810	2,254	2,578	2,923
Target Price (JPY)				58,500
Upside (Based on fair PE ratio of 20X)				15.8%
Each fiscal year ends 31 March. FY25 refers to the 12-month period ended 31 March 2025. Source: Bloomberg Finance L.P., iFAST Estimates. Data as of 29 Dec 2025.

Figure 9: Share price vs. EPS chart for the Nikkei 225 Index

Declaration:

For specific disclosure, at the time of publication of this report, the analyst who produced this report and IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities.