Japan’s economy shrank 1.8% on an annualized basis in the July–September quarter, marking its first decline in six quarters. The slowdown arose from softer exports, weak consumer spending, and regulatory pressures.
The contraction, slightly below economists’ expectations, highlights the ongoing fragility of Japan’s economic recovery. Exports weighed heavily on growth, as trade tensions—especially tariffs on shipments to the United States—reduced output. Net external demand is subtracted from the overall quarterly growth.
Private consumption, which makes up more than half of Japan’s GDP, has grown by only 0.1%. High living expenses and stagnant wages have led households to be cautious, with limited discretionary spending on goods and services.
Meanwhile, housing investment suffered too on the back of changes in building regulations, as well as tighter financing, with residential expenditure plunging. On the bright side, businesses also increased capital spending by about 1%, driven by strong business sentiment and targeted investments in equipment and factories.
Government rolls out major stimulus amid rising inflation
Inflation remains high, with core consumer prices rising significantly above the Bank of Japan’s target of 2%. Soaring prices for staples such as energy and food continue to put pressure on households.
Meanwhile, Prime Minister Sanae Takaichi is preparing an ambitious economic stimulus package, valued at over ¥17 trillion (around US$110 billion). Measures are expected to include subsidies on electricity and gas bills, cuts to gasoline taxes, targeted tax breaks, and strategic investment in growth industries such as AI and semiconductors.
The government plans to fund the package through a large supplementary budget, likely exceeding last year’s additional spending of ¥13.9 trillion. Policymakers struggle to ensure that they are providing strong fiscal support while being responsible for its fiscal implications. Monday’s GDP numbers boost political support for aggressive fiscal spending. But Japan’s already elevated public debt raises concerns about long-term financial stability.
The Bank of Japan is also in a delicate position. Although weak output may temper near-term interest rate increases, inflation remains persistent. Policymakers have emphasized caution, aiming to strike a balance between supporting growth and maintaining price stability.
The Prime Minister, Takaichi, has called for “wage-driven inflation,” one that sees price rises corresponding not only to higher costs but also to higher incomes.
Consumers cut back on spending
Private consumption, which constitutes more than half of Japan’s economy, slowed markedly in Q3. Many households scaled back their spending as prices for necessities such as food, electricity, and gas increased further.
Increased costs are stretching household budgets, resulting in less disposable income for discretionary spending on items such as dining out, travel, and entertainment.
Consumer confidence was still delicate. Surveys indicate that many families are concerned about the future, particularly regarding job security and the impact of inflation on their financial stability. From the same BOJ survey (September 2025 wave), 62.5% said things are worse than a year ago, while only 3.8% said they felt things had improved
Firms scaled back spending on new projects and growing operations or facilities, either because demand from here or abroad was softer. Firms have maintained their own cautious streak amid economic unease, as trade pressure from overseas has continued unabated. Housing spending softened again during the quarter.
The construction of new homes and real estate development slowed, as higher interest rates and building costs discouraged both builders and homebuyers.
Weak household spending, combined with restrained business investment, has exacerbated the damage caused by declining exports, resulting in a decline in overall GDP.
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