Why we’re raising Japan’s growth forecasts

We expect Japan’s GDP to contract in the third quarter (-0.3% quarter-on-quarter, seasonally adjusted) following the unwinding of export front-loading seen in the second quarter.

Yet recent data – including stronger-than-expected industrial production and facility investment – suggest the economy bottomed out by the end of the June-August period. We expect exports to rebound thanks to the finalisation of the US trade deal and a weaker JPY, which may help mitigate the impact of tariffs.

On the domestic demand side, we expect private consumption to continue recovering. The new government is crafting an economic package equivalent to nearly 2.5% of the country's GDP, with plans to present it during the current Diet session, which runs until mid-December. The priority is to lower inflation and reduce some tax rates, which should boost private consumption. However, the new ruling government still lacks a majority in both houses. So, Prime Minister Sanae Takaichi must compromise on bills and budgets to gain the support of the opposition.

We believe that the budget bill will eventually pass, but its size will likely be reduced. In addition, corporate earnings have been quite solid despite the US tariff headwinds. This could enable wage growth above 3% for the next fiscal year. Coupled with the recent asset market rally, this should be supportive for household spending.

Tokyo's hotter-than-expected CPI in October increases the likelihood of a near-term Bank of Japan rate hike. October is typically when companies adjust final prices for the latter half of the fiscal year. We saw prices rise in both labour-intensive services and manufactured goods. This development aligns with the BoJ's goal to initiate a virtuous cycle of wage growth and sustained inflation.

Looking ahead, headline inflation should slow in 2026, mostly thanks to government measures and lower global commodity prices. Yet strong wage growth above 3% could have companies passing input price gains onto consumers. The recent weakness in JPY may keep core inflation elevated above 2%. Also, although Takaichi does not advocate for the BoJ's rate hikes, she has not made explicit statements regarding monetary policy either. Given the increased attention on BoJ policy from the US, she is unlikely to make comments on this matter without careful consideration. Thus, with the real interest rate still negative and easing downside risks on growth, we expect the BoJ to deliver a 25bp rate hike in December.