Japans Economy Likely Shrank Last Quarter as Tariffs Hit Hard

Japan’s economy is expected to have contracted in the third quarter after five consecutive periods of growth, driven by the impact of U.S. tariffs on exports. The data is set to be released on Nov. 17 and could influence policy decisions as Japan navigates a fragile political transition and economic challenges. The report is critical for understanding how external trade pressures and domestic policy decisions are shaping the world’s fourth-largest economy.

Introduction
The quarterly GDP report is a key indicator of Japan’s economic momentum and provides insights into how the nation is adapting to global trade dynamics and domestic policy. The data plays a central role in shaping monetary policy expectations for the Bank of Japan and informs fiscal strategies under the leadership of new Prime Minister Sanae Takaichi. With global trade tensions and internal political shifts, the timing of the data release is particularly significant.

Data Overview and Context
The GDP report is expected to show that Japan’s economy contracted at an annualized rate of 1.2% in the third quarter, compared to the previous quarter. This would mark a reversal from five consecutive quarters of growth. The data is based on a Bloomberg survey of 58 economists. Below is a summary of key data points and expectations:

| Metric | Previous Forecast (Q2 2025) | Current Forecast (Q3 2025) | Source |
|--------|-----------------------------|-----------------------------|--------|
| Annualized GDP Growth | 0.1% | -1.2% | Bloomberg Survey |
| Non-Annualized Export Drop (Q3 vs. Q2) | -3.1% | -4.0% | Bloomberg Survey |
| Private Consumption Growth | - | 0.5% | Bloomberg Survey |
| Core Inflation Rate | 3.4% | 3.5% | Ministry of Internal Affairs and Communications |

The data is sourced from the Ministry of Internal Affairs and Communications and is compiled using a standard national accounts methodology. However, the report is subject to revisions in subsequent releases and may not fully capture the long-term impact of tariffs or policy shifts.

Analysis of Underlying Drivers and Implications
The expected contraction is primarily attributed to the impact of U.S. tariffs, which have significantly reduced export volumes. According to the Bloomberg survey, exports are projected to have fallen by 4% in the third quarter compared to the previous period. This decline is driven by a sharp drop in shipments to the U.S., despite a July trade agreement that stabilized tariffs at 15%. The agreement, while reducing the rate from 27.5%, still exerts pressure on Japanese exporters, who have had to lower prices to remain competitive.

Domestically, private consumption remains a key source of support, with wages rising due to strong labor negotiations. However, inflation remains above the Bank of Japan’s 2% target, eroding purchasing power. The combination of external trade headwinds and internal inflationary pressures could lead to a reevaluation of Japan’s economic strategy under Takaichi.

The political landscape adds further uncertainty. Takaichi’s pro-growth agenda is expected to include additional fiscal support, but her government must first secure a coalition with Komeito. The delay in coalition talks highlights the challenges she faces in stabilizing the political front while managing economic pressures.

Policy Implications for the Bank of Japan
The Bank of Japan is scheduled to deliver its next policy decision on Oct. 30. Governor Kazuo Ueda has indicated openness to a near-term rate hike but emphasized the need to monitor the impact of U.S. tariffs on the economy. The expected GDP contraction may push the BOJ to slow its tightening cycle, particularly if inflation shows signs of easing. Markets are currently pricing in a 22% chance of a rate hike at the next meeting, but this could shift depending on the final GDP data and subsequent economic indicators.

Market Reactions and Investment Implications
The expected GDP contraction has already influenced market sentiment, with the yen hitting an eight-month low against the dollar. A weaker yen has positive implications for Japanese exporters but increases import costs and inflationary pressure. The currency’s decline may also influence BOJ policy decisions, with the possibility of market intervention if the yen moves closer to the 160 mark.

Fixed-income markets have priced in a cautious outlook for the BOJ, with Japanese government bond yields remaining stable. Equity markets are showing mixed signals, with export-dependent sectors under pressure and domestic consumption-linked stocks performing relatively better. Investors should closely monitor the October 30 BOJ meeting and the Nov. 17 GDP release for further direction.

Conclusion & Final Thoughts
Japan’s economy is at a crossroads, with external trade pressures and internal political dynamics shaping its economic trajectory. The expected contraction in Q3 highlights the immediate challenges posed by U.S. tariffs, while the political uncertainty under Takaichi adds an element of unpredictability. The Bank of