After Japan’s economy grew by 5.9 percent in the first quarter, its fastest growth in three years, it is little surprise that the Bank of Japan (BOJ) decided to stand pat on its monetary policy at its most recent meeting. While April’s increase in the country’s sales tax from 5 percent to 8 percent initially appears to have dented consumer demand somewhat, most of the other economic indicators in the country appear positive.

Capital expenditures by Japanese business rose by the most ever in March, helped along by a weakened yen which boosted exports. Japan’s trade deficit shrunk in April as the sales tax increase reduced demand for imports, which rose just 3.4 percent in the month to JPY6.88 trillion. Meanwhile, exports rose by 5.1 percent to JPY6.07 trillion, largely thanks to improved demand for Japanese machinery and transportation equipment. While the US remained Japan’s largest trading partner, exports to China rose nearly 10 percent.

In March the country’s inflation rate was running at 1.6 percent. While that’s still slightly shy of the BOJ’s 2 percent target, core consumer prices hit a 22-year high in Tokyo last month. Labor unions also bargained hard in what is known as the annual “spring labor offensive”, securing the first wage increases many Japanese have seen in years in the first quarter. Many of the 52 major exporters in the country, such as Toyota Motor (NYSE: TM) and Panasonic (Tokyo: 6752), and other large employers reported their first base pay increases since 2008.

High pay was a key piece in the government’s economic recovery puzzle and based on that and other positive indicators, the BOJ actually dropped its traditional reference to deflation in its economic forecast.

Still, the bank maintained its pledge to increase Japan’s monetary base by between JPY60 trillion and JPY70 trillion per year, at least until inflation is at a sustainable 2 percent. And while it didn’t take additional action at yesterday’s meeting, I suspect we’ll see further easing before the year is out.

While some of the slowing demand due to the tax increase is likely to reverse, particularly thanks to wage increases, I doubt it will fully recover to its pre-April levels quickly. At the same time, the improving Japanese economic outlook has also pushed the yen to its highest level in three months, a clear challenge for the country’s exports. So while the BOJ seems to be at its most confident level in years, I strongly suspect BOJ Governor Haruhiko Kuroda will intervene to help knock the yen off its newfound high horse, most likely at the bank’s October meeting. The country just can’t afford a strong currency at this stage of the game.

While the Japanese economy looks to be at its strongest level in decades, Prime Minister Shinzo Abe must still push through with key reforms in order for it to be sustainable, particularly in the labor arena.

When Abe took office he described a “three arrow” plan to revive the Japanese economy. The first two arrows, loosening monetary policy and more responsible fiscal policy, have so far hit pretty close to the bull’s eye but the third arrow, major reform effort, has really yet to be loosed. Largely thanks to its shrinking population, the country must raise its productivity level to continue growing, corporate taxes should likely be lowered from its current 36 percent rate and protective labor practices must be addressed. Abe has said that he will address all of those issues, most recently at a meeting with the Bank of England a few weeks ago, but that it has proven more difficult than was expected so far. But to give credit where credit is due, Abe’s bottom-up approach to addressing Japan’s economic weakness has been much more successful so far than his predecessors top-down program which attempted to address difficult reforms right out of the gate.

While it is still too early to say that Japan is out of the woods, it has so far made more progress in addressing its challenges than it has in the past 30 years.