By Makiko Yamazaki and Leika Kihara
TOKYO (Reuters) -Japanese business sentiment was steady in the three months to September, a closely watched survey showed, a sign the economy remained on track for a moderate recovery that leaves scope for further interest rates hikes by the central bank.
But companies remained cautious about the outlook with service-sector firms projecting business conditions to sour over the next three months, the Bank of Japan's "tankan" survey showed on Tuesday, as weak global growth and volatile financial markets cloud the outlook.
The tankan will be among key factors the BOJ will scrutinise in setting monetary policy and releasing fresh growth and inflation forecasts at its next meeting on Oct. 30-31.
The headline index measuring big manufacturers' business confidence was +13 in September, unchanged from June and matching median market forecasts, the survey showed.
The sentiment index for big non-manufacturers rose slightly to +34 from +33 in June, exceeding market forecasts of +32, as price hikes lifted retailers' profits, the tankan showed.
"Despite the yen's rebound since mid-July, big manufacturers' business sentiment remains unexpectedly solid," said Takeshi Minami, chief economist at Norinchukin Research Institute. "Overall results are positive, considering various risk factors such as a stronger yen, pressure to raise wages and downside risks to the global economy."
Despite the yen's 11% surge in the third quarter, big manufacturers set their dollar/yen estimate for the current fiscal year at 144.96, up from 142.68 in the June survey. The dollar stood at 143.725 yen on Tuesday.
Big companies expect to increase capital spending by 10.6% in the fiscal year to March 2025, the tankan showed, smaller than a median forecast for an 11.9% gain and down from an 11.1% increase three months earlier.
Companies expect inflation to stay above the BOJ's 2% target one, three and five years ahead, the tankan showed, backing up the central bank's view that Japan was making progress towards durably achieving its price goal - a prerequisite for hiking still-low interest rates.
But the survey found Japanese companies remain cautious about the outlook.
While big manufacturers expect conditions to improve three months ahead, non-manufacturers project conditions to worsen, the tankan showed.
"Momentum among non-manufacturers could have already faded, including hotels and restaurants that had been boosted by inbound tourism," said Masato Koike, senior economist at Sompo Institute Plus.
The weak yen has given a boost to exports and retailers benefiting from a surge in inbound tourism. The recent rebound in the yen would hurt exports and inbound tourism, but ease the pain on retailers and households from rising import costs.
The BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25% in July on the view Japan was making steady progress towards durably achieving its 2% inflation target.
BOJ Governor Kazuo Ueda has said the central bank will continue to raise rates if companies keep hiking prices and wages due to optimism over the outlook, and help keep inflation durably around its 2% target.
"For the BOJ, today's tankan was evidence that things were on track. Its rate-hike cycle will likely continue," said Toru Suehiro, chief economist at Daiwa Securities.
"The focus shifts to how the yen's rise affects business sentiment and inflation. That would be the key point to scrutinise at the next tankan," he said.
The next tankan is due on Dec. 13, roughly a week before the BOJ's policy meeting on Dec. 18-19.
Japan's economy expanded an by annualised 2.9% rate in the second quarter as steady wage hikes underpinned consumer spending. Capital expenditure continues to grow, though soft demand in China and slowing U.S. growth cloud the outlook for the export-reliant country.
The tankan's sentiment diffusion indexes are derived by subtracting the number of respondents who say conditions are poor from those who say they are good. A positive reading means optimists outnumber pessimists.