Japan's economy stumbles as consumers and businesses stop spending

Japan's economic expansion decelerated during the April-to-June period of 2026, with gross domestic product rising by only 0.3 percent compared to the previous quarter. This marked the third consecutive quarter of growth but represented a significant slowdown from the 0.5 percent expansion recorded in the first three months of the year. The figure also fell short of economists' expectations, who had anticipated a 0.5 percent quarterly increase. On an annualized basis, the world's fourth-largest economy grew by 1.1 percent, substantially below the 1.67 percent forecast by a survey of 37 economists conducted by the Japan Center for Economic Research.

The disappointing performance was primarily driven by weakness in domestic demand. Private consumption remained flat in real terms, indicating that Japanese households are hesitant to spend amid rising living costs. More concerning was the sharp decline in capital expenditure, which fell by 1.2 percent from the previous quarter, or 4.6 percent on an annualized basis. This drop in business investment offset the positive contribution from exports. When broken down by component, net exports contributed 0.5 percentage points to GDP growth, while domestic demand dragged down the overall figure by negative 0.2 percent, highlighting the economy's reliance on external trade for what little growth it achieved.

Several factors are contributing to the economic headwinds facing Japan. The country imports nearly all of its crude oil requirements, making it particularly vulnerable to elevated energy costs resulting from geopolitical tensions, specifically the fallout from the United States-Israel war on Iran. These cost pressures have been exacerbated by the weakness of the Japanese yen, which reached a 40-year low against the US dollar in the preceding month. Norihiro Yamaguchi, lead economist for Japan at Oxford Economics, warned that growth is expected to remain sluggish in the second half of 2026 as companies begin passing rising energy costs on to consumers. He noted that while AI-related goods exports should remain robust in the near term, sluggish non-AI-related global economic activities will limit overall export gains.

The weaker-than-expected growth figures could complicate monetary policy decisions for the Bank of Japan. The central bank has been attempting to normalize its policy after decades of ultra-low and negative borrowing costs. In June, the BOJ raised its benchmark interest rate to 1 percent, the highest level in more than three decades, following its first rate hike since the 2008 global financial crisis in 2024. The upcoming interest rate decision in September will now be made against a backdrop of faltering economic momentum. Despite the disappointing GDP data, Japan's stock market showed resilience, with the benchmark Nikkei 225 rising 0.3 percent. Other Asian markets also posted gains, with South Korea's KOSPI up 2.4 percent and Hong Kong's Hang Seng Index advancing 1.6 percent.