Japan’s economy slowed in the second quarter of 2026, missing growth forecasts as private consumption stagnated and capital spending contracted, according to official figures released by the Cabinet Office on Monday.
Gross domestic product rose 0.3 percent in the April-June period from the first quarter, down from 0.5 percent growth in the previous three months and below the 0.5 percent that analysts had forecast. On an annualized basis, the world’s fourth-largest economy expanded 1.1 percent, falling short of the two percent growth that markets expected. A survey of 37 economists conducted by the Japan Center for Economic Research had projected annualized growth of 1.67 percent.
It was the third consecutive quarter of expansion. On a year-on-year basis, the economy grew 0.7 percent, up from 0.5 percent in the first quarter. But the composition of growth was lopsided. Exports were the main driver, contributing 0.5 percentage points to the GDP figure, while domestic demand dragged growth down by 0.2 percentage points. Shipments from the country beat expectations in all three months of the quarter, though that strength was helped by the weak yen rather than a higher volume of goods sold abroad.
Energy shock hits households and businesses
This was the first full quarter to reflect the impact of the Iran war, which has pushed energy prices higher for both businesses and households. Japan imports almost all of its crude oil needs, leaving it exposed to elevated energy costs stemming from the fallout of the United States-Israel war on Iran. Cost pressures on consumers have been compounded by the weakness of the yen, which last month hit a 40-year low against the US dollar.
Private consumption was flat in real terms. Capital expenditures fell 1.2 percent on a quarterly basis, or 4.6 percent annualized, offsetting the strength in exports. Norihiro Yamaguchi, lead Japan economist at Oxford Economics, noted that non-durable goods purchases and service consumption dipped as consumer sentiment worsened. The drop in domestic demand was also driven by a reduction in public inventories, which Yamaguchi identified as the government’s release of national oil reserves to cope with the Middle East conflict.
Yamaguchi said he expected growth to remain sluggish in the second half of 2026 as companies pass rising energy costs on to consumers. “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,” he wrote in a note to clients. He added that while AI-related goods exports would stay strong in the near term, sluggish non-AI-related global economic activity would limit overall export gains.
Bank of Japan faces a complicated decision
The weaker-than-expected figures could complicate the Bank of Japan’s upcoming decision on interest rates. The central bank, which will hold its next policy meeting on September 17 and 18, raised its benchmark rate to one percent in June, the highest in more than three decades. An interest rate hike in September could help alleviate the chronic weakness of the yen by narrowing the large gap in borrowing costs between Japan and other major economies, especially the United States. Japan’s central bank began moving away from its ultra-loose monetary policy in 2024, when it announced its first rate hike since the 2008 global financial crisis.
Earlier this month, the Bank of Japan released its economic activity outlook and marginally raised its GDP growth forecast to 0.6 percent from 0.5 percent for the fiscal year ending March 2027. The central bank said Japan’s economy is expected to continue growing moderately, albeit at a decelerated rate, pointing to high crude oil prices from the Middle East conflict. It said this was likely to be partially offset by government measures to curb high oil prices for households and an increase in global AI-related demand, as many Japanese companies are involved in the semiconductor supply chain.
Markets reacted calmly to the data. The benchmark Nikkei 225 finished up more than 0.7 percent amid a broader rally across Asia. The yield on the benchmark 10-year Japanese Government Bonds stood at 2.88 percent. The yen strengthened slightly against the dollar, trading at 159.1. South Korea’s KOSPI gained 2.4 percent, while the Hang Seng Index in Hong Kong and the SSE Composite Index in Shanghai both climbed about 1.4 percent. In Taiwan, the TAIEX closed up 0.1 percent.