Japan’s economy expanded by an annualized 1.1% in the second quarter, falling short of the anticipated 2% growth. This softer performance was primarily driven by weak domestic demand and declining consumption, which offset a boost from strong exports.
Geopolitical factors, including the Iran war and its impact on energy prices, also contributed to the deceleration, leading to a cautious outlook from economists despite the Bank of Japan’s slightly raised growth forecast.
Japan’s economic engine sputtered slightly in the second quarter, registering an annualized growth rate of just 1.1%, significantly missing market expectations of a 2% expansion. While robust exports provided some uplift, the nation’s economic health was ultimately dragged down by a notable softening in domestic demand.
The latest figures reveal a quarter-on-quarter growth of 0.3%, also below the 0.5% forecast. On an annual basis, the economy expanded by 0.7%, a modest increase from 0.5% in the preceding quarter.
This period marks the first full quarter to reflect the economic ripple effects of the ongoing Iran war, which has sent energy prices climbing for both businesses and households, adding another layer of complexity to Japan's economic landscape.
Despite the GDP miss, financial markets showed a mixed reaction. The Nikkei 225 index edged up 0.43%, while the yield on the benchmark 10-year Japanese Government Bonds settled at 2.88%. The Japanese yen saw a slight strengthening against the U.S. dollar, trading at 159.1.
Exports emerged as a key pillar of growth, surpassing expectations for all three months of the quarter. However, analysts note that this strength was largely bolstered by a weaker yen, making Japanese goods more competitive abroad, rather than a substantial increase in shipment volumes alone. While exports contributed 0.5 percentage points to the GDP figure, the persistent weakness in domestic demand counteracted this, shaving off 0.2 percentage points from overall growth.
According to Norihiro Yamaguchi, lead Japan economist at Oxford Economics, the dip in domestic demand was primarily due to a reduction in public inventories. This was specifically identified as the government’s release of national oil reserves, a strategic move to mitigate the impact of the Middle East conflict on energy supplies.
Further compounding the domestic challenges, consumer spending offered another unwelcome surprise. Yamaguchi highlighted a decline in purchases of non-durable goods and a decrease in service consumption, indicating a worsening consumer sentiment. Business investment also contracted on a quarterly basis, reflecting cautious corporate outlooks.
Earlier in the month, the Bank of Japan (BoJ) adjusted its economic activity outlook, marginally raising its GDP growth forecast for the 2026 fiscal year (ending March 2027) from 0.5% to 0.6%. The central bank projects that "Japan's economy is expected to continue growing moderately, albeit at a decelerated rate," attributing potential headwinds to high crude oil prices stemming from the Middle East conflict.
However, the BoJ anticipates these challenges will be partially offset by governmental measures aimed at curbing oil prices for households, alongside a projected surge in global AI-related demand, given the significant role Japanese companies play in the semiconductor supply chain.
Yamaguchi of Oxford Economics presented a more cautious stance on inflation, warning that "The boost to consumption from policy measures is already fading, and inflation will increase in H2 as firms will pass on increased costs, deteriorating consumers' purchasing power." This suggests that consumers may face a squeeze on their finances as businesses inevitably transfer higher operational costs.
