Japan’s Economy Expands 1.1% in Second Quarter as Domestic Demand Weakens

Real gross domestic product increased 0.3% from the previous quarter, equivalent to an annualized growth rate of 1.1%, according to preliminary figures released by Japan’s Cabinet Office on Monday. The result fell short of economists’ median forecasts for 0.5% quarterly growth and a 2% annualized increase.

The latest data nevertheless showed that Japan’s economy continued to expand during the April-to-June period despite pressure from higher energy costs and uncertainty linked to the conflict in the Middle East.

On a year-over-year basis, real GDP was 0.7% higher, compared with a 0.5% increase in the first quarter, according to the Cabinet Office figures.

Exports Help Keep Growth Positive

External demand provided the strongest support to the economy during the quarter.

Exports of goods and services increased 0.5% from the previous quarter, while imports fell 1.5%. Net exports contributed roughly 0.5 percentage points to overall GDP growth.

Japan’s exporters have continued to benefit from overseas demand for automobiles and technology-related products, while global investment linked to artificial intelligence has supported parts of the semiconductor supply chain.

The weak yen has also provided support to export-oriented companies by increasing the value of overseas earnings when converted back into the Japanese currency.

At the same time, a weaker currency can raise the cost of imported energy and raw materials, placing additional pressure on businesses and households.

Domestic Demand Weighs on Economy

The domestic side of the economy presented a weaker picture.

Domestic demand reduced quarterly GDP growth by around 0.2 percentage points, according to the government data.

Private consumption was broadly flat, ending a period of stronger household spending as higher prices continued to affect purchasing power.

Business investment was particularly weak, with private non-residential investment falling 1.2% quarter on quarter. Residential investment declined 0.5%, while public investment edged down 0.1%.

Government consumption, however, increased 1.6%, providing some support to economic activity.

The figures suggest Japanese households and businesses are becoming more cautious as elevated living costs and geopolitical uncertainty weigh on confidence.

Middle East Tensions Add Pressure

The April-to-June period was the first full quarter to reflect the economic effects of heightened tensions in the Middle East.

Japan is heavily dependent on imported energy, leaving the economy particularly vulnerable when crude oil prices rise or international supply routes are disrupted.

The Bank of Japan has warned that higher oil prices could weaken corporate profits and household real incomes during fiscal 2026. The central bank expects the economy to continue expanding, but at a slower pace this fiscal year.

The BOJ has also highlighted government measures aimed at limiting the impact of higher electricity, gas and fuel costs on households.

BOJ Sees Moderate Growth Ahead

Despite the softer second-quarter GDP reading, the Bank of Japan remains cautiously positive about the economic outlook.

In its July outlook, the central bank raised the median growth forecast for fiscal 2026 to 0.6%, from 0.5% in its April projection. Most Policy Board members expect growth between 0.6% and 0.7% during the fiscal year ending March 2027.

The BOJ said strong global demand associated with artificial intelligence, continued wage increases and supportive financial conditions should help underpin the economy even as higher energy prices create headwinds.

However, inflation remains an important concern.

The central bank expects core consumer inflation to rise clearly above its 2% target during the second half of fiscal 2026, partly because companies are expected to pass higher energy, semiconductor and other input costs on to consumers.

Growth Outlook Remains Uneven

Japan’s latest GDP figures underline the mixed forces shaping the world’s fourth-largest economy.

Exports and demand connected to technology and artificial intelligence are providing support, while household spending and corporate investment are facing pressure from higher costs.

The balance between those forces will be closely watched in the coming months, particularly as the Bank of Japan considers future monetary policy decisions.

For now, the second-quarter figures point to continued economic expansion, but at a pace that remains vulnerable to inflation, energy prices and changes in global demand.

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