Market Update: We break down the business implications, market impact, and expert insights related to Market Update: Japan economic outlook | Deloitte Insights – Full Analysis.
Growth in slow gear
Prior to the political upheaval, Japan’s economy grew by an annualized rate of 2.2% between the first and second quarters of 2025.4 The relatively strong performance was largely due to an improvement in the trade balance as exporters rushed to get goods across the border before US tariffs went into effect. This is unlikely to be repeated in subsequent quarters.
Business investment was also relatively strong, rising an annualized 2.6% over the same period—the third consecutive quarter with growth above 2%. Other categories were more subdued. For example, final domestic household consumption grew just 1.3%.5 Meanwhile, government spending fell for a second consecutive quarter as public investment continued to decline.
Excluding international trade, the economy grew by about 1%, which points to relatively weak domestic demand. Since the second quarter, domestic demand seems to have waned. The real consumption activity index was unchanged from a year earlier in July.6 This was entirely due to slower nominal spending rather than higher inflation. Consumer confidence has improved somewhat since hitting a low in April, but remained 6.3% lower than a year earlier in August.7
A government survey of business conditions shows that large companies are less optimistic than they were a year earlier in the third quarter.8 They are even less optimistic about the fourth quarter of this year.
A large obstacle to stronger growth and confidence in the economy is coming from elevated inflation. Even so, the Bank of Japan (BOJ) left its policy rate unchanged again in September despite relatively high inflation. Two voting members dissented, opting for a rise in interest rates instead.9 Still, the BOJ announced that it would sell some of its exchange-traded funds and real estate investment trusts. The central bank has expressed concern that US trade policy could weaken Japan’s growth prospects, requiring a more dovish monetary policy stance.10 The presence of two dissenters, combined with recent comments from other BOJ officials, signals that the central bank could raise rates before the end of this year. Plus, headline inflation and core inflation, which excludes fresh food, are firmly above the central bank’s 2% target.
However, additional rate hikes are by no means certain as the durability of inflation remains questionable. Headline inflation is moving due to factors unrelated to domestic demand. For example, energy and government subsidies for education were the main contributors to the recent drop in headline inflation.11 At the same time, food prices are pushing inflation in the other direction. Rice prices were up 49.1% from a year ago, while the prices of coffee, cakes, and candies are also rising quickly.
Food items are currently the principal drivers of inflation. When fresh food and energy are excluded from prices, core-core inflation was 3.1% in September on a year-ago basis. But if we exclude all food and nonalcoholic beverages in addition to energy, western core inflation was just 1.3%—the lowest reading since September 2022 (figure 1). This means that most of the inflationary impulse in the economy is coming from food items that do not fall in the fresh food category—mainly rice, cakes and candies, and coffee.12