Japan's GDP shrank for the first time in six quarters, with a decline smaller than expected, and the 10-year Japanese government bond yield hit a seventeen-year high.

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Due to weak domestic demand and the impact of US tariffs, Japan's economy contracted in the third quarter, but the contraction was less severe than economists had generally expected, mainly thanks to stable corporate capital expenditure offsetting sluggish private consumption. This report highlights the fragility of Japan's economic recovery and may further complicate the Bank of Japan's policy path.

On Monday, November 17, the latest data released by the Japanese government showed that Japan's GDP shrank at an annualized rate of 1.8% quarter-on-quarter in the third quarter, better than the market expectation of a 2.5% decrease, but a sharp reversal from the 1.6% growth in the second quarter. On a quarter-on-quarter basis, GDP shrank by 0.4%, also better than the expected -0.6%, while the previous quarter saw an increase of 0.5%.

The main driving factor behind this economic contraction is the simultaneous slowdown of both domestic and external demand engines. Private consumption, accounting for about half of the economy, nearly stagnated, while a global economic slowdown and trade tensions made net exports a drag on economic growth.

After the release of this data, expectations for an imminent rate hike by the Bank of Japan cooled somewhat. Investors and analysts are now turning their attention to possible fiscal stimulus plans from the new Prime Minister Sanae Takaichi, in hopes of providing support for the sluggish economy.

After the GDP data was released today, the USD/JPY exchange rate rose 0.01% to 154.56.

Japan's 10-year government bond yield rose 2 basis points to 1.720%, a new high since June 2008.

Capital expenditures a surprising bright spot as both domestic and external demand engines stall

Despite overall economic headwinds, corporate investment displayed resilience and became a rare bright spot in this data set. Third-quarter capital expenditure grew 1.0% quarter-on-quarter, well above the market consensus of 0.3%.

Data show that despite weak external demand, large Japanese companies have continued to increase capital spending, especially in strengthening local infrastructure. Strong corporate investment helped offset weakness in other areas of the economy, providing crucial support for the GDP data and avoiding a sharper decline.

However, the robust performance of capital expenditure cannot mask the double predicament facing Japan's economy: weak internal consumption and soft external demand. Data show that in the third quarter, domestic and external demand each dragged down GDP growth by 0.2 percentage points.

Internally, private consumption, the most important pillar of the economy, grew only 0.1%, in line with expectations. The report pointed out that persistent inflation and weak wage growth have suppressed household spending willingness, and consumer attitudes remain cautious. Externally, with global economic growth slowing and the continued impact of US tariffs and other trade frictions, Japan's exports fell 1.2% quarter-on-quarter in the third quarter, making net exports a drag on economic growth.

More uncertainty for policy outlook

This complex economic report presents challenges for Japan's policymakers. On one hand, data show that inflationary pressure persists: the third-quarter GDP deflator rose 2.8% year-over-year, in line with expectations, providing a reason for the Bank of Japan to consider policy normalization.

On the other hand, the economy has already turned to contraction, limiting the Bank of Japan's room for tightening policy. According to Reuters, traders have generally reduced bets on a Bank of Japan rate hike in the short term, partly due to limited economic strength and potential political resistance. As a result, the market focus is shifting more towards fiscal policy, watching whether the new government will stimulate the economy through increased fiscal spending.

According to Japanese media, Prime Minister Sanae Takaichi will announce as early as this week an economic stimulus plan totaling up to 17 trillion yen to address sluggish economic growth. However, analysts pointed out that this move would further worsen the already high debt problem of the Japanese government.

In terms of monetary policy, economic stagnation has made the Bank of Japan's push for policy normalization even more difficult. Analysts believe that economic uncertainty will inevitably delay the Bank of Japan's timetable for normalizing monetary policy.

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