Confidence is at high levels already, so there is little room for further gains in the diffusion index. Especially capital investment plans at large manufacturers are extremely strong. The companies expect continued strong demand from Asia and the U.S. This optimism is reinforced by the fact that an expected Yen appreciation has not materialized so far. The companies are now more optimistic that external demand remains strong while the domestic economy improves gradually.

The companies are gaining from long-delayed replacement investments. The IT sector is booming for example. The companies also start to see the effects of increasing household demand at restaurant and the department stores. Also, real estate investors still try to lock in current low interest rates. Finally, financial and employment conditions are still positive for small corporations, so the companies remain optimistic that the strong economy will continue to tickle into the household sector and stronger demand.

Investment at the large manufacturers is very strong. But much of this investment is still driven by replacements in capital stock and overseas investment. Non-manufacturers and smaller companies tread much more carefully. Since companies also see little chance to increase output prices, the risk of general overheating remains limited.

Since companies focus on external demand and investment, the exchange rate and interest rates are the obvious risk factors. But both risks are rather limited. Bond demand remains strong, inflation low, and the BOJ careful; so interest rate hikes are not a major risk. The Yen can appreciate at anytime. But corporations now have a much more balanced international production network; so exchange rate risks look limited as well. The companies will be strongly taxed by high raw materials prices and tax hikes, however, so their profits remain sensible to any changes in demand conditions.

The BOJ has warned that it would react early on any sign of investment overheating. On basis on stronger inflation and investment data, an early interest rate step has become much more likely. But the situation is more complicated. Inflation pressures and investment plans are still strongly linked to overseas demand, not the domestic economy. So the BOJ needs to be very careful to not harm domestic demand while deterioration of overseas demand remains to be a risk factor. A likely current scenario is that the BOJ comments on an end ZIRP as early as next week, moves in August or September, but keeps rates surprisingly low.