Japan's sputtering economy likely stalled before Trump's tariffs

Japan Times

12-05-2025

Japan's economy likely suffered a contraction in the first three months of this year, signaling underlying fragility even before U.S. tariff measures started hitting the country in earnest, according to economists surveyed by Bloomberg.
Gross domestic product adjusted for inflation shrank by 0.3% in the first quarter on an annualized basis, according to the median estimate of economists. That result would mean the first quarterly drop in a year.
A decline would cast a shadow over both the Bank of Japan's plans to steadily continue with policy normalization and Prime Minister Shigeru Ishiba's election hopes this summer. It also highlights the weaknesses in Japan's economy even before it was hit by stringent tariffs from its biggest security partner, and raises the chance of a technical recession.
In the preliminary GDP data due Friday, forecasters expect several factors to be at play. They see a big drag from net exports after a drop in imports gave an unexpected boost in the previous quarter, while consumer spending is seen as remaining stagnant amid elevated inflation.
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"There's no engine to drive Japan's economy at the moment,' said Yoshiki Shinke, senior executive economist at Dai-Ichi Life Research Institute. "This is even before the Trump tariffs hit. I see a good chance of another quarter of contraction following right after.'
Any clear signs of weakness will add to Japanese policymakers' list of headaches amid few signs of Japan and the United States nearing a trade agreement. Commerce Secretary Howard Lutnick last week said "an enormous amount of time' is needed to reach deals with Japan, just as U.S. President Donald Trump announced a framework agreement with the United Kingdom.
Friday's data is also likely to support the BOJ's wait-and-see stance. Earlier this month, Gov. Kazuo Ueda's board signaled a one-year delay in its expected timing for reaching its stable inflation target. It also halved its growth outlook for this fiscal year, the biggest cut since the release of the projection in 2023.
Following the dovish signs from the latest policy meeting, which ended May 1, many BOJ watchers including Goldman Sachs and Barclays have pushed back their call for when they expect the next rate hike from the central bank.
"The BOJ will probably have to wait at least until next year,' said Masamichi Adachi, chief Japan economist at UBS Securities and a former BOJ official. "You can't rule out a chance that the focus for the BOJ shifts to a rate cut by the end of the year.'
Japan's biggest companies are beginning to slash their profit forecasts due to the tariffs. Last week Toyota Motor reported that its profits will sink by about one-third this fiscal year compared to last year. The details of the tariffs are "still incredibly fluid, so it's difficult to take steps,' CEO Koji Sato said at a briefing.
Shrinking corporate profits will fuel concerns over the sustainability of Japan's inflation-wage cycle. Consumer spending has been lackluster as real wages have been falling for a good part of the past three years as the cost of living overall has risen well above the BOJ's 2% target.
"Japan is having its own version of stagflation,' Adachi said. "Consumer spending isn't robust enough to support a moderate recovery on the whole.'
Partly due to inflation, Ishiba has seen his popularity drop to the lowest level since he took office in October. Any weak GDP data will likely fuel ongoing political debates over a fresh economic package ahead of a summer upper house election.
To be sure, Japan's GDP data have a history of surprises and large revisions. For the preliminary report for the three months through December, the Cabinet Office reported that annualized GDP grew 2.8%, more than double the median estimate of 1.1%, driven by a fall in imports. This time, consumer spending for services could be unexpectedly solid as new service sector data have been showing surprising jumps, Shinke said.
Japan's potential growth rate is estimated to be around 0.6%, the lowest among Group of Seven countries, according to the Cabinet Office. That raises the risk of the economy shrinking with even a small shock to the system. An economic contraction last quarter would mark its sixth since 2021, compared with twice in the U.S.
"Of course a major risk is being created by Trump — one person. So the outlook could shift dramatically if he changes his mind,' Shinke said. "But it's hard to be upbeat about the economy right now and I can't deny the chance of a recession.'