Japan's Economy Contracts Sharply in Q1 2025 Amid Export Slump and Weak Demand

Japan’s economy shrank more than expected in the first quarter of 2025, dragged down by falling exports and stagnant consumer spending. Official data released Friday showed gross domestic product (GDP) declined 0.7% year-on-year, sharply missing forecasts of a 0.2% drop and reversing the previous quarter’s 2.4% growth. On a quarterly basis, GDP contracted 0.2%, deeper than the 0.1% decline analysts had predicted.

The primary drag came from external demand, which fell 0.8% quarter-on-quarter, exceeding expectations of a 0.6% drop. Japan’s export sector was hit hard by growing uncertainty over global trade, fueled by the U.S. administration’s sweeping tariff measures. President Donald Trump implemented a blanket 10% tariff on all imports, along with additional levies targeting foreign vehicles and select commodities, creating headwinds for Japanese exporters.

A strengthening yen added to export pressures, with rising safe haven demand and a hawkish Bank of Japan supporting the currency’s value. Meanwhile, private consumption remained flat in Q1, disappointing expectations for a 0.1% increase. Despite substantial wage hikes in early 2024, their effect has waned, although new wage negotiations in spring 2025 could reinvigorate spending in the coming months.

On a positive note, capital expenditure rose 1.4% quarter-on-quarter, beating forecasts of 0.8%, offering some support to the overall economic picture. However, with domestic growth slowing, the Bank of Japan may face challenges in tightening monetary policy further.

Inflation remained persistent, with the GDP deflator rising 3.2% year-on-year, matching expectations. Overall, Friday’s data signals a cooling Japanese economy facing external trade headwinds, currency challenges, and muted consumer activity, potentially limiting the scope for rate hikes in the near future.