the nonmanufacturing sector that is at the forefront of the recovery. since the nonmanufacturing sector is more labor - intensive than the manufacturing sector, this has resulted in a tightening of labor market conditions. in the construction, retail, and service sectors, some firms have found it difficult to expand their business due to labor shortages. according to the tankan survey, excess capacity has almost disappeared. with the high level of capacity utilization, there have been more frequent disruptions of the smooth operation of production. all in all, the output gap has been moderately improving to reach around 0 percent recently and has turned positive in the january - march quarter of this year due partly to the front - loading of demand prior to the consumption tax hike ( chart 12 ). with the economy expected to continue growing at a pace above its potential, that is, with growth in demand exceeding growth in supply capacity, the positive output gap is likely to expand gradually. therefore, inflationary pressure from the output gap is likely to steadily increase. rising medium - to long - term inflation expectations let me move on to inflation expectations. medium - to long - term inflation expectations appear to have been rising on the whole ( chart 13 ). this, in turn, has started to affect wage and price setting. for example, as seen in wage negotiations this spring, the rise in inflation is increasingly being taken into account in wage setting between management and labor. moreover, firms ’ price - setting strategies have been changing. under deflation, many firms pursued low - price strategies by putting priority on cost reductions since there had been a strong preference among consumers for low - priced products. recently, however, an increasing number of consumers have been purchasing goods and services even at somewhat higher prices as long as their quality was in line with their price. in response, some firms have started to raise sales prices while increasing value added in terms of the quality and functionality of the goods and services they provide. in the output prices di of the tankan survey, until recently the share of firms responding that their output prices are “ falling ” exceeded that responding that their output prices are “ rising ; ” however, in the june survey the two shares were identical ( chart 14 ). thus, the mechanism in which the rise in observed inflation alters people ’ s inflation outlook and behavior, which in turn raises observed inflation, continues to operate. this means that people ’ s inflation expectations will likely follow an uptrend and inflationary pressure from

than to hire new employees. these investments will lead to a more efficient utilization of labor amid a tightening labor market and eventually raise labor productivity. third, more than a year has passed since the correction of the excessive appreciation of the yen and firms have been reviewing the location of their global production bases. in the phase of yen appreciation after the global financial crisis, the share of firms ’ overseas investment increased, and this trend continued for some time even amid the correction of the excessive appreciation of the yen. this is because firms need a certain period of time between the decision to invest at home or abroad and the actual subsequent implementation. recently, there have finally been signs that firms are planning to increase the share of domestic investment. for example, some firms regard japan as the base for the manufacturing of and research and development for strategically important products, as well as for improving production processes, and have been investing or planning investment in these areas. overseas economies and japan ’ s exports let me turn to developments in exports. exports have recently more or less leveled off despite the correction of the excessive appreciation of the yen ( chart 9 ). the relatively lackluster performance of exports is essentially due to cyclical factors, including the sluggishness in emerging economies with strong economic ties with japan such as the asean countries. at the same time, however, structural factors may have also played a certain role. such factors include the accelerated relocation of production overseas by japanese firms reflecting the appreciation of the yen and a decline in international competitiveness in sectors such as it - related goods in which japanese firms have traditionally had a competitive advantage. in addition, temporary factors putting downward pressure on exports seem to have had an impact through early spring, although this impact bis central bankers ’ speeches has been waning. such temporary factors include the effects of the unusually severe winter weather in the united states and the fact that firms placed priority on domestic shipments in response to the front - loading of demand prior to the consumption tax hike. future developments in exports to a great extent will depend on the performance of overseas economies, which are expected to continue to recover moderately, led by advanced economies. this is also confirmed by the world economic outlook by the international monetary fund : global economic growth, which slowed to 3. 2 percent in 2013, is projected to accelerate gradually to 3. 4 percent in 2014 and 4. 0 percent in 2015 ( chart 10 ). japan ’ s exports are likely to increase moderately due mainly to this recovery in overseas economies. in fact