Japan manufacturing growth slows in March as oil, yen, and war bite

Factory revival loses steam as Middle East war drives costs to 19-month high.

Japan's manufacturers closed the first quarter of 2026 in expansion for the second month running, but the pace slowed sharply in March as the war in the Middle East stoked the fastest cost inflation in nearly a year and a half and dampened business confidence across the sector.

The S&P Global Japan Manufacturing PMI slipped to 51.6 in March from a 45-month high of 53.0 in February — still indicative of improvement, but at the slowest and most modest pace of the current upturn, and the second-strongest performance of the sector since July 2022.

Factory output continued to grow, extending the current period of expansion to three months, though the pace eased from February and was the second-quickest since April 2022. New orders also expanded for the third consecutive month, driven by demand for semiconductors, AI technology, and automotive products — though here too the rate of growth was the softest of the three-month run.

Investment goods makers led the field. Producers of investment goods recorded the sharpest improvement in conditions, whilst intermediate goods registered a modest upturn. The consumer goods sector, however, deteriorated in March.

Employment continued to rise, but the momentum faded. The rate of job creation was the slowest seen in 2026 to date, and the increase in payrolls was insufficient to prevent a further rise in backlogs of work — the most pronounced accumulation of outstanding business since June 2022. Firms cited efforts to expand capacity and address chronic labour shortages as the motivation for hiring.

The war in the Middle East cast the longest shadow over the cost data. Input price inflation reached its sharpest rate since August 2024, driven by higher raw material and energy costs, with a weak yen and rising labour expenses adding further pressure. Faced with mounting cost burdens, manufacturers raised their selling prices at the second-quickest pace since June 2024.

Supply chains continued to fray. Supplier lead times lengthened again in March, with panellists reporting product shortages at vendors — semiconductors noted in particular — though the deterioration was less acute than in February.

S&P Global Market Intelligence economics associate director Annabel Fiddes said the conflict was now feeding directly into Japan's economic gauges. "The slowdown coincides with the outbreak of war in the Middle East, which according to survey respondents directly contributed to stronger cost pressures at the end of the first quarter. Notably, input prices rose to the greatest extent in over a year-and-a-half, leading firms to raise their charges at a quicker pace as they sought to protect their margins," she said.

Fiddes added that the war had also unsettled longer-term planning. "The war has fuelled greater uncertainty about the global economic outlook, dampening business confidence and resulting in more cautious hiring and purchasing activity," she warned, adding that coming months of PMI data would be critical in assessing whether supply chain and cost pressures continued to build.

Looking ahead, manufacturers remained broadly optimistic, pinning hopes on sustained demand from the AI, semiconductor, and defence industries. Business sentiment softened from February's recent high but held broadly in line with the survey's long-run trend, tempered by caution over the Middle East conflict.

Despite the March slowdown, the sector achieved its strongest quarterly performance since the second quarter of 2022.