Japan's economy slows more than expected; exports insufficient for strong growth

Japan's economy expanded at a slower pace than anticipated in the second quarter of 2026, with annualized GDP growth recorded at 1.1 percent. This figure represents a deceleration from the 1.9 percent growth seen in the previous three months and fell short of the average forecast of 2.1 percent. Quarterly growth also eased from 0.5 percent to 0.3 percent.

This period marks the first full quarter reflecting the impact of the conflict in the Middle East, which has led to increased energy costs for businesses and households. Kazutaka Maeda, an economist at Meiji Yasuda Research Institute, noted, "Growth was positive, but the details were somewhat weaker than expected."

The main engine for this growth was exports, which exceeded expectations throughout the quarter, largely supported by a weak yen. However, domestic demand contracted. Norihiro Yamaguchi, chief Japan economist at Oxford Economics, attributes this decline primarily to the reduction in public inventories, linked to the government's release of national oil reserves to mitigate the effects of the Middle East conflict. Consumer spending also surprised on the downside, with purchases of non-durable goods and services declining amid worsening sentiment.

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Growth was positive, but the details were somewhat weaker than expected.

Yoshiki Shinke, an economist at Dai-ichi Life Research Institute, pointed out that some of the weakness in consumption was due to one-off factors, such as the shift of spending towards government consumption initiatives like free school lunches. He added that factors burdening capital expenditure, such as uncertainty from the Middle East conflict, are diminishing, and business investment plans remain solid. "Overall, we can say that the economy remained resilient, despite slower-than-expected growth," Shinke commented.

Looking ahead, the Japanese economy is expected to continue a path of moderate recovery. Minoru Kiuchi, Japan's Minister of Economy, stated, "The economy remains on a path of moderate recovery, with export-driven growth offsetting domestic demand weakness. Strong wage growth and policy support are likely to sustain the recovery, while the impact of the Middle East situation warrants caution." The Bank of Japan recently revised its GDP growth forecast for fiscal year 2026 upwards to 0.6 percent from 0.5 percent, anticipating continued moderate growth, albeit at a slower pace, influenced by high oil prices stemming from the Middle East conflict.

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The economy remains on a path of moderate recovery, with export-driven growth offsetting domestic demand weakness. Strong wage growth and policy support are likely to sustain the recovery, while the impact of the Middle East situation warrants caution.