Japan's Economy Shrinks 0.2%, First Contraction in a Year as Exports Fall

Japan's economy contracted for the first time in a year, falling 0.2% in the March quarter as exports fell sharply, according to preliminary government data released Friday.

The GDP data was lower than the 0.1% contraction predicted by economists polled by Reuters.

On an annualized basis, Japan's GDP fell 0.7% in the first quarter, exceeding the 0.2% decline predicted by Reuters.

Exports fell 0.6% quarter on quarter, subtracting 0.8 percentage points from GDP, as uncertainty caused by US President Donald Trump's trade policies impacted Japan's export-heavy economy.

On a year-on-year basis, Japan's GDP increased by 1.7%, the most since the first quarter of 2023 and a stronger performance than the 1.3% growth seen in the fourth quarter.

Japan's GDP data comes at a time when the country is embroiled in trade negotiations with the United States, with initial talks between the two sides failing to yield a conclusive agreement.

On Friday, Ryosei Akazawa, Japan's top trade negotiator, reportedly stated that US tariffs had no significant impact on Japan's first-quarter GDP.

However, he warned of economic risks from US trade policy and stated that the government would "take all necessary steps" to assist affected firms.

While job and wage gains would likely support a moderate economic recovery, Akazawa warned that sustained price increases posed risks to consumer sentiment and consumption.

According to Krishna Bhimavarapu, Asia-Pacific Economist at State Street Global Advisors, Japan's GDP growth was lower than expected, but domestic demand increased by 0.6%, making it a "bright spot" and "very good."

Bhimavarapu anticipates a "reasonable deal with the United States" in the coming months, which will reduce the tariff impact.

"All this will mean that the Bank of Japan will comfortably sit on the sidelines till certainty emerges as we expect just one hike this year, perhaps in Q4," according to him.

On May 1, the Bank of Japan maintained interest rates at 0.5% for the second consecutive meeting.

The BOJ also warned on May 13 that the country's economy would likely moderate in the future, citing the effects of global trade policies.

"Negative demand shocks are expected, including the impact of increased uncertainties on business fixed investment and household consumption, a decrease in the volume of exports to the United States and a deterioration in Japan's export profitability," according to the BOJ.

The US tariff policy will put downward pressure on both economic activity and prices in Japan, according to the central bank.

Despite these growth concerns, the central bank appears poised to continue raising its policy rate, with some BOJ board members stating that the bank's 2% inflation target is likely to be met, and that the policy rate would be raised further if its economic activity and price forecasts are met.

Japan's inflation had exceeded the BOJ's 2% target for three years in a row, with the most recent reading of 3.6% in April.

Other board members, however, warned that the outlook is uncertain, stating that the bank should "examine the possibility of both upward and downward deviations from its outlook and conduct monetary policy as appropriate."