Global market: Japan Q2 GDP misses estimates, but BOJ rate hike bets remain intact

Japan’s economy grew at a slower-than-expected pace in the April-June quarter, as weak household consumption and business investment offset resilient exports, while uncertainty linked to the Middle East conflict continued to weigh on confidence.

Gross domestic product expanded at an annualised rate of 1.1% in the second quarter, government data showed on Monday. The reading fell short of the 2.0% median forecast in a Reuters poll and was below the revised 1.9% growth recorded in the January-March quarter.

On a quarter-on-quarter basis, the economy grew 0.3%, compared with the 0.5% expansion expected by economists.

Consumption weighs on growth

Private consumption was a major drag on the economy, declining 0.02% in the second quarter. It was the first contraction in eight quarters and contrasted with market expectations for a 0.5% increase.

Consumption, which accounts for more than half of Japan’s economic output, was affected by several temporary factors. Earlier policy and regulatory changes had boosted demand for automobiles and air conditioners, while measures such as free education and higher tobacco prices weighed on overall household spending.

Economists viewed much of the weakness as temporary and said it did not necessarily point to a sustained deterioration in domestic demand.

Household spending and wage growth remain important indicators for the Bank of Japan as it assesses the strength of the economy and determines the timing of further interest rate increases.

Business investment falls

Capital spending also disappointed, falling 1.2% in the second quarter against economists’ expectations for a 0.4% increase.

Analysts attributed part of the weakness to uncertainty stemming from supply-chain disruptions associated with the Middle East conflict. The calculation was also affected by the overseas sale of a large pharmaceutical patent asset, which was recorded as a decline in capital expenditure and an increase in exports of research and development services.

Despite the weak domestic components, economists said corporate investment plans remained relatively firm and that some of the factors depressing spending were likely temporary.

Exports provide support

Net external demand added 0.5 percentage point to overall GDP growth, largely because imports fell sharply following temporary disruptions to crude oil shipments through the Strait of Hormuz.

Exports remained relatively resilient, supported by strong US demand for Japanese hybrid vehicles and continued global investment in artificial intelligence. Demand for AI-related infrastructure helped sustain shipments of semiconductor equipment and components.

The contribution from external demand provided some relief as domestic consumption and investment struggled.

BOJ rate hike expectations remain

Despite the weaker-than-expected headline GDP figure, economists said the data was unlikely to immediately derail expectations for another Bank of Japan rate increase.

Analysts largely viewed the weakness in consumption and capital spending as being driven by temporary factors, while underlying economic momentum remained relatively resilient. A rate hike as early as September remains a possibility.

However, economists cautioned that the central bank could move more gradually if household spending remains under pressure.

Rising import costs also pose a potential risk. A weaker yen and higher crude oil prices could increase costs for businesses and eventually lead to broader price increases for consumers later this year.

Outlook turns more cautious

Private consumption could weaken further in the July-September quarter as the temporary boost from automobile and air-conditioner purchases fades.

At the same time, strong wage growth and government policy support are expected to support domestic demand. The impact of the Middle East conflict, however, remains a key risk for Japan’s growth outlook.

A survey by the Japan Center for Economic Research showed that 37 economists expect annualised GDP growth to slow to an average of just 0.05% in the July-September quarter.

The latest figures therefore leave the Bank of Japan facing a delicate balance: inflation and wage gains could justify further policy tightening, but softer household spending and investment may encourage policymakers to proceed cautiously.

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