Japan’s economy grew more slowly than expected in the second quarter as weaker domestic demand offset strong exports, underscoring the pressure that higher energy costs and deteriorating consumer sentiment are placing on the country’s recovery.
Gross domestic product expanded at an annualized 1.1% pace in the three months through June, according to government data, below the 2% growth economists had expected and sharply slower than the revised 2.1% pace recorded in the first quarter.
On a quarter-on-quarter basis, GDP increased 0.3%, also missing the 0.5% forecast.
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The second-quarter figures mark the first full quarter to capture the impact of the Iran war, which pushed energy prices higher and increased costs for Japanese households and businesses.
Exports provided the main support for growth. Shipments increased throughout the quarter and contributed 0.5 percentage points to the quarterly GDP increase. The strength of exports, however, was partly supported by the weaker yen rather than a comparable increase in the underlying volume of goods shipped.
Domestic demand subtracted 0.2 percentage points from growth, highlighting the uneven nature of Japan’s recovery.
Norihiro Yamaguchi, lead Japan economist at Oxford Economics, said the decline in domestic demand was largely linked to a reduction in public inventories, which reflected the government’s release of national oil reserves to help address the energy shock caused by the conflict in the Middle East.
Household consumption also weakened.
Yamaguchi said purchases of non-durable goods and services declined as consumer sentiment deteriorated. Business investment also contracted on a quarterly basis, adding another drag to economic activity.
On a year-on-year basis, Japan’s economy grew 0.7% in the second quarter, accelerating from 0.5% in the first quarter.
The data point to a difficult policy environment for the Bank of Japan. Strong exports and continued demand related to the global AI and semiconductor investment cycle are providing support for the economy, but weaker household spending and higher energy costs threaten to undermine domestic growth.
Japan’s exposure to the global semiconductor industry could provide an important source of resilience. Japanese companies supply equipment, materials and components used throughout the semiconductor manufacturing chain, leaving the economy positioned to benefit from continued investment in AI infrastructure and advanced chips.
The Bank of Japan raised its growth forecast earlier this month, projecting the economy would expand 0.6% during the fiscal year ending March 2027, slightly higher than its previous 0.5% forecast.
“Japan’s economy is expected to continue growing moderately, albeit at a decelerated rate,” the central bank said, while pointing to the impact of elevated crude oil prices resulting from the Middle East conflict.
Government measures to contain higher energy costs could cushion households and support consumption. The BOJ also expects stronger global AI-related demand to provide an offset, particularly given Japan’s role in the semiconductor supply chain.
The inflation outlook, however, remains a concern.
Yamaguchi said the boost to household spending from government policy measures is already fading and warned that companies could pass higher input costs on to consumers during the second half of the year.
“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 said.
That combination of weak consumption and persistent cost pressures could complicate the BOJ’s efforts to normalize monetary policy. If inflation remains elevated because of higher energy and other input costs while domestic demand weakens, policymakers face a more difficult trade-off between containing inflation and supporting growth.
Financial markets showed a relatively muted response to the GDP data. The Nikkei 225 was up 0.43%, while the yield on the benchmark 10-year Japanese government bond stood at 2.88%. The yen strengthened slightly against the dollar, trading at around 159.1 per dollar.
The figures leave Japan’s economic outlook dependent on whether external demand can continue to compensate for weakness at home.
For now, exports, AI-related investment and government support for energy costs are providing important cushions. But according to economists’ perspective, unless household consumption and business investment regain momentum, the economy could struggle to sustain the pace of expansion needed to meet the BOJ’s expectations.