Japan returns to growth but remains sluggish; Q4 2025 GDP annualized quarterly rate at 0.2%, below expectations, expansionary fiscal policy supported.

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Although Japan reversed the deep contraction seen in the previous quarter, economic growth in the fourth quarter of 2025 remained far below market expectations. This weak performance provided support for Prime Minister Sanae Takaichi’s advocacy of expansionary fiscal policy and also put the Bank of Japan’s rate hike path to the test.

Data released by Japan's Cabinet Office on Monday showed that the preliminary quarter-on-quarter growth of real GDP in the fourth quarter last year was 0.1%, below the market expectation of 0.4%, with the previous value at -0.7%. In annualized quarter-on-quarter terms, GDP’s preliminary value for the quarter was only 0.2%, far short of the expected 1.6%, narrowly halting the 2.6% contraction in the third quarter. Detailed data showed consumer spending increased 0.1%, capital expenditure grew 0.2%, and net exports contributed nothing to growth.

Although growth fell far short of expectations, analysts believe this is not enough to shake the Bank of Japan's plan to raise rates later this year. The return to positive growth itself gives the central bank room to continue tightening monetary policy, despite the recovery being mild.

Weak Growth in Consumption and Investment

Looking at detailed data, private consumption, which accounts for more than half of GDP, increased by only 0.1% in the fourth quarter, significantly slower than the 0.4% growth in the third quarter. Although companies have continued to raise wages in recent years, persistently rising food prices put pressure on household spending, with average real monthly wages recording a year-on-year decline throughout 2025.

Capital expenditure also showed weak performance, growing only 0.2%, far short of Reuters survey expectations of 0.8%. Shinichiro Kobayashi, chief economist at Mitsubishi UFJ Research and Consulting, pointed out:

“Interest rate rises and wage growth may pose a dual risk to small and medium-sized enterprises, thus limiting their capacity for capital spending.”

Exports showed differentiation. Exports fell 0.3% in the fourth quarter, a smaller decrease compared to 1.4% in the previous quarter, showing that the initial impact of tariffs had gradually been absorbed, but incoming tourism was hit.

Influenced by Sanae Takaichi's remarks last November, China issued a warning against travel to Japan, with the number of Chinese tourists falling sharply in the fourth quarter. According to Xinhua News Agency, Ouyang An, Director of China’s tourism office in Tokyo, said Takaichi’s recent erroneous statements had already had a substantive impact on cultural and tourism exchanges between China and Japan. As the Chinese government issued travel and study abroad alerts, airlines also introduced free cancellation and change policies, reducing Chinese tourists’ willingness to visit Japan.

Bank of Japan’s Rate Hike Path Faces a Test

Despite GDP growth in the fourth quarter being far below expectations, analysts believe this is not enough to shake the Bank of Japan’s plans to raise interest rates later this year.

Stefan Angrick, an economist at Moody’s Analytics, expects the Bank of Japan will raise rates again in July. However, he also warned that if subsequent growth data fails to show more substantial improvement, the rationale for further rate hikes will be challenged. Since raising rates in December last year, the Bank of Japan has maintained its policy rate at the 30-year high of 0.75%.

Takeshi Minami, chief economist at Nomura Research Institute, holds a cautious stance on near-term actions. He noted:

“Although GDP returned to positive growth, the momentum is weak. Coupled with the need to assess the impact of the December rate hike, the likelihood of further hikes in the short term seems diminished.”

Takaichi’s Fiscal Expansion Plan Gains Support

Weak fourth quarter GDP data provided more support for Takaichi’s implementation of expansionary fiscal policy after her victory in this month's general election. The Liberal Democratic Party won two-thirds of seats in the House of Representatives, setting a postwar record for a single party and ensuring the smooth passage of the new fiscal year’s budget in April.

According to Bloomberg, Takaichi is considering accelerating discussions on whether to temporarily abolish the food sales tax and promises to offset the corresponding tax losses without relying on deficit bonds. Marcel Thieliant, economist at Capital Economics, noted:

“Weak economic activity increases the possibility of Takaichi pushing for a suspension of the food sales tax. It is possible she may formulate a supplemental budget in the first half of the new fiscal year.”

Japanese Economy Minister Minoru Kiuchi reiterated the official position, saying “the economy continues to moderately recover,” and stated that as the effects of various policies become apparent and employment and income conditions improve, moderate growth is expected to be supported.

Cautious Market Response

After the release of weak GDP data, the Japanese market response was generally mild. Bond futures rose slightly, indicating investors are reassessing the Bank of Japan's monetary policy outlook. The stock market was weak, with the Nikkei index closing down 0.14% at 56,860.75 points.

Kobayashi, economist at Mitsubishi UFJ Research and Consulting, is cautious about the outlook for consumption. He warns that while export goods appear to have bottomed out, the export of inbound services has turned negative, which is worrying. He pointed out:

“Personal consumption shows some resilience, but whether this resilience can be sustained depends on whether price easing measures prove effective, and whether real wages can return to positive growth.”

Looking ahead, economists expect Japan’s economy to continue expanding at a gradual pace. A survey by the Japan Center for Economic Research this month showed 38 economists forecast average annualized GDP growth of 1.04% in the first quarter, and 1.12% in the second quarter.

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