Investing.com – Japanese stocks are expected to benefit in coming years from an improving local economy, UBS analysts said in a note, although they continue to forecast trade-related headwinds from increased U.S. tariffs.

UBS expects the benchmark to end 2025 at 41,500 points and next year at 2,900 points, which is about a 5% boost from current levels but slightly lower than UBS’s previous forecasts.

The brokerage expects that increased U.S. tariffs under President-elect Donald Trump will have a negative impact on Japanese companies, especially those with export exposure.

However, UBS also expects the Japanese economy to post nominal growth amid persistent inflation and higher wage increases. The brokerage said Japan’s planned corporate governance reforms also raise the potential for higher returns for shareholders and better overall value.

Still, UBS also warned that a high tariff scenario would make it complex for the Japanese economy to avoid a recession, and the brokerage recommended shifting to sectors with exposure to domestic demand.

Japan’s domestic sectors will improve in the coming years

UBS expects the Bank of Japan to raise its key interest rate to 1% by the end of 2025 amid rising wage increases and persistent inflation. Private consumption is expected to benefit greatly from this trend.

“We take a bullish stance on consumer-related sectors such as retail and food, which have lagged the Japanese stock market over the past two years, believing that the dynamics of consumption recovery and industrial restructuring will increase as real wages rise,” they wrote in a note UBS analysts.

The brokerage also recommended sectors such as housing, real estate, IT services and telecommunications due to their exposure to local demand.

However, UBS noted that political turmoil in the country could pose a downside risk, especially after a coalition led by the ruling Liberal Democratic Party failed to win a majority in the last general election.