Japan: Economy recovers less strongly than expected in Q4 2025
GDP reading: Japan’s GDP increased 0.2% on a seasonally adjusted quarter-on-quarter annualized (SAAR) basis in Q4, following a 2.6% contraction in the prior quarter. Still, the reading was far below economists’ expectations, with high inflation weighing on consumer spending.
Drivers: Compared to the prior quarter’s data, readings in Q4 improved for government consumption (+0.6% on a seasonally adjusted quarter-on-quarter annualized (SAAR) basis vs +0.5% in Q3), fixed investment (+2.5% vs -6.8% in Q3) and exports of goods and services (-1.1% vs -5.5% in Q3). In contrast, readings worsened for private consumption (+0.4% vs +1.6% in Q3) and imports of goods and services (-1.3% vs -0.5% in Q3).
As anticipated, exports shrank less sharply as Japanese firms adjusted to higher U.S. tariffs; however, less positively, consumer spending decelerated more sharply than expected as a result of elevated inflation and higher interest rates.
In annual terms, the economy increased 0.1% in Q4, following a 0.6% expansion in the prior quarter.
GDP outlook: GDP growth (in seasonally adjusted, annualized terms) is set to remain around 1% through at least the end of 2027, according to our Consensus Forecast. This relatively weak pace of growth reflects structural constraints such as an ageing and declining population and greater global protectionism, as well as cyclical headwinds including higher interest rates set by the Bank of Japan.
Still, the fiscal stimulus proposed by Prime Minister Sanae Takaichi could lead our panelists to raise their forecasts for GDP growth in 2026 ahead. In December, the government passed a supplementary budget worth USD 122 billion, and plans for a larger budget in the upcoming fiscal year starting April are in the works following Takaichi’s recent resounding election victory. Planned measures include a two-year suspension of the 10% consumption tax, which should support consumer spending.
Other key factors to watch ahead include the pace of wage growth plus the impact of U.S. tariffs on the global economy and external demand for Japanese goods.
Panelist insight: EIU analysts said:
“We expect Japan’s growth momentum to remain modest in 2026, with real GDP expanding by just under 1%. We believe that the continuation of strong nominal wage growth, together with moderating inflation, will deliver modest but positive real wage growth, which will provide support for household spending. Government expenditure will remain elevated as more resources are needed in policy areas beyond cost-of-living alleviation, including health and welfare spending, industrial rejuvenation and defence enhancement.”
Economists at HSBC commented on the implications of the data for the Bank of Japan:
“In our view, the Bank of Japan’s (BoJ) rate hike trajectory remains intact. During its last Monetary Policy Meeting, the BoJ’s Policy Board upgraded inflation and growth forecasts, reflecting optimism that a virtuous wage-inflation cycle is taking hold. All eyes are now on the Shunto spring wage negotiations — if average pay rises exceed 5% for a third year running, real wage growth could rise in H2 2026 as inflation moderates. Our base case remains that the BoJ will conduct a 25bp hike in July, lifting the policy rate to 1.00%.”