Insights 
VT 
Japan’s Services PMI for May 2025 was recorded at 51.0, up from the preliminary estimate of 50.8 but down from the previous month’s 52.4. The Composite PMI was 50.2, a slight increase from the preliminary 49.8, yet down compared to April’s 51.2.
The manufacturing PMI for May 2025 was finalised at 49.4, rising from April’s 48.7, yet still indicating contraction. Service sector growth experienced a slowdown attributed to a drop in demand and the slowest new business growth since November.
Employment Growth Trends
Employment growth within the services sector was the weakest since December 2023. Business sentiment improved from earlier in the year but remained subdued relative to the post-pandemic norm.
Persistently high input costs have kept inflation pressures high. The stagnation in manufacturing and rising costs have nearly halted private sector growth, resulting in the composite PMI dropping to 50.2.
What the current figures tell us is that momentum in Japan’s broader economy continues to cool. Output in services may still be expanding, but it’s doing so at a less energetic pace, and the drop from April suggests that demand-side conditions are softening more deeply than initially expected. Service providers seem to be contending with weakening client pipelines, and the data reveals that fresh orders are growing at their slowest pace in six months. From our point of view, that appears to reflect heightened caution at a consumer level, perhaps tied to the ongoing pressure of higher prices.
Manufacturing Sector Insights
The situation in manufacturing offers little immediate encouragement. Although the finalised reading ticked up compared to April, it’s clear the sector remains in contraction. A PMI under the 50.0 threshold, however slight, tells us quite firmly that factories are seeing reduced output and demand — this isn’t a matter of rounding error or temporary softness, it’s an evident stagnation in industrial activity.
On the employment front, things are also looking weaker. Hiring has slowed in services, and while there hasn’t yet been an outright decline in job creation, the fact that this is the lowest reading since late 2023 points to subdued confidence in forward orders and revenue. Firms will usually curb recruitment when they start feeling uncertain about future activity levels. That’s what makes the slight uptick in sentiment somewhat difficult to read — while businesses may hope for stronger conditions, they’re not staffing up in line with that optimism.
Inflation appears to be the anchor dragging down otherwise modest progress. Input costs are still running high and, based on regional supply dynamics and energy prices, there’s little to suggest that trend will shift downwards quickly. These cost burdens are being passed along where possible, likely contributing to weaker discretionary demand in services. What’s left is a narrow expansion in the composite index — a figure just above 50 — driven mostly by dwindling service momentum rather than any positive contribution from industry.
For those of us watching price behaviour in the short-term interest rate curve or FX volatility, the readings help calibrate expectations for potential monetary reactions. The central bank is unlikely to respond hastily while growth remains tepid and cost-driven inflation persists. That dynamic tends to push near-term hedging activity into lower conviction trades.
Short-dated option skews may begin to reflect higher protection demand on downside moves, and implied vol surfaces could steepen slightly, especially in risk-linked yen crosses. We need to consider the possibility that weaker business conditions in both services and manufacturing might start leaking further into pricing expectations. That could influence the forward rates market with slightly firmer views on rate path extensions, even in the face of inflation.
In any case, it’s prudent not to chase noise here. These PMI figures, while below seasonal averages, are not indicating an aggressive downturn. Positioning through the next cycle requires measured risk calibration, particularly as liquidity looks thinner into mid-summer.
