Japan’s economy expanded 1.1% in the second quarter on an annualised basis, falling short of expectations for 2% growth as weaker domestic demand countered robust exports. The figure was compared to the 2.1% in the previous quarter. This marks the inaugural complete quarter reflecting the ramifications of the Iran war, which has resulted in elevated energy prices for both businesses and households. Following the data release, the Nikkei 225 experienced an increase of 0.43%, while the yield on the benchmark 10-year Japanese Government Bonds stood at 2.88%. The yen exhibited a modest appreciation relative to the dollar, with a trading value of 159.1.

Exports served as the primary catalyst for growth, with shipments from the country surpassing expectations for each of the three months in the quarter. However, this was aided by the weak yen rather than merely an increase in shipment volume. In comparison to the initial quarter of 2026, GDP experienced an increase of 0.3%, falling short of the anticipated 0.5% growth. Exports added 0.5 percentage points to the GDP figure; however, this was offset by weaker domestic demand, which reduced growth by 0.2 percentage points. The decline in domestic demand was primarily attributed to a decrease in public inventories, which was recognised as the government’s release of national oil reserves to address the Middle East conflict, as stated by Norihiro Yamaguchi.

Consumption presented another unexpected development, as Yamaguchi noted, indicating that purchases of non-durable goods and service consumption declined amid deteriorating sentiments. Business investment also contracted on a quarterly basis. On a year-on-year basis, the country’s economy expanded by 0.7%, an increase from the 0.5% recorded in the first quarter. Earlier this month, the Bank of Japan released its economic activity outlook and raised its GDP growth forecast slightly to 0.6% from 0.5% for the fiscal year 2026, which concludes in March 2027. “Japan’s economy is expected to continue growing moderately, albeit at a decelerated rate,” the central bank said, pointing at high crude oil prices from the conflict in the Middle East.

However, this is likely to be partially counterbalanced by government measures aimed at curbing elevated oil prices for households, alongside a rise in global demand related to artificial intelligence. Numerous Japanese firms participate in the semiconductor supply chain. Yamaguchi was more pessimistic on inflation, and said “The boost to consumption from policy measures is already fading, and inflation will increase in H2 as firms will pass on increased costs, deteriorating consumers’ purchasing power.”