Japan’s economy contracted in the first quarter, with preliminary gross domestic product (GDP) data showing a 2.0% annualized drop from the prior quarter, which was faster than expected. This marks the second consecutive quarter of economic decline, with GDP barely growing in the fourth quarter. Private consumption, which accounts for over half of the Japanese economy, also fell more than expected at 0.7%, marking the fourth consecutive quarter of decline, the longest streak since 2009. Capital spending, a key driver of private demand, also fell in the first quarter, despite strong corporate earnings.
While Japan’s economy hit a bottom in the first quarter, economists are predicting a rebound in the following quarter due to rising wages, although there is uncertainty surrounding service consumption. External demand from exports minus imports also contributed to the contraction, lowering first quarter GDP estimates by 0.3 of a percentage point. Policymakers are expected to rely on rising wages and income tax cuts from June to stimulate consumption, and factors such as the recovery from an earthquake in the Noto area and the resumption of operations at Toyota’s Daihatsu unit are also expected to help boost growth.
Despite the positive developments, concerns have been raised about higher living costs due to a sharp decline in the yen to levels not seen since 1990. This has the potential to squeeze consumption, creating further challenges for policymakers. The Bank of Japan raised interest rates in March for the first time since 2007, moving away from negative rates, but the central bank is expected to proceed cautiously in unwinding easy money conditions given the fragility of the economy.
Overall, the first quarter contraction in Japan’s economy presents a fresh challenge to policymakers as they look to lift interest rates away from near-zero levels. The decline in private consumption and capital spending, combined with concerns about higher living costs, create a complex economic environment that requires careful management. Despite predictions of a rebound in the following quarter, uncertainties remain regarding the sustainability of this growth, especially in the face of external challenges such as the decline in the yen and the impact of natural disasters on the economy.
Moving forward, policymakers will need to focus on implementing measures to stimulate consumption while also addressing the broader economic issues at play. Rising wages and income tax cuts are expected to help boost consumer spending, but a delicate balance will need to be struck to ensure sustainable growth. The Bank of Japan’s cautious approach to raising interest rates reflects the need for careful navigation of the economic landscape, with a focus on supporting continued recovery and stability in the Japanese economy.
