Japan’s economy continued to expand in the second quarter of 2026 despite higher energy costs, a weak yen and cautious household spending. Real gross domestic product increased by 0.3% in April-June compared with the previous three months, equivalent to an annualised growth rate of 1.1%, according to preliminary government data released on August 17.
The result marked a third consecutive quarter of economic expansion, but growth was weaker than economists had expected. The median forecast was for GDP to rise 0.5% quarter-on-quarter and 2.0% at an annualised rate. Growth also slowed from the revised 1.9% annualised expansion recorded in the first quarter.
One of the main weaknesses was household consumption. Private consumption was virtually unchanged, slipping by about 0.02% and ending eight consecutive quarters of growth. This is particularly important because consumer spending accounts for more than half of Japan’s economy.
Japanese households continue to face pressure from elevated food and energy prices. The weak yen makes imported fuel, food and raw materials more expensive, limiting the improvement in purchasing power even as wages increase.
Business investment provided another warning signal. Capital expenditure fell 1.2% from the previous quarter, against expectations for an increase. The decline suggests that some companies remain cautious about new investment amid uncertainty surrounding global trade, energy prices and the wider economic outlook.
The external sector performed better. Exports of goods and services increased by about 0.5%, supported partly by overseas demand for Japanese automobiles and technology-related products. Hybrid vehicles remain important for Japanese manufacturers in the United States, while investment associated with artificial intelligence and data centres is supporting demand for semiconductors and related equipment.
Imports fell by around 1.5%, partly reflecting lower volumes of imported energy. As a result, net external demand made a significant contribution to overall GDP growth even though export growth itself was relatively modest.
Government consumption also provided support, increasing by around 1.6%. This helped offset some of the weakness in household spending and private investment.
A major risk for Japan is its dependence on imported energy. The country imports most of the oil and natural gas it consumes, making the economy particularly vulnerable to supply disruptions and price increases linked to instability in the Middle East.
Tensions surrounding Iran and shipping routes through the Strait of Hormuz have added to concerns about energy costs. Higher oil prices mean a larger import bill for Japan, higher production costs for companies and additional pressure on household budgets.
The weak yen adds another layer of complexity. The Japanese currency has recently traded around 160 yen to the U.S. dollar. A weaker currency benefits major exporters because overseas earnings translate into more yen and Japanese products can become more competitive internationally.
But the same exchange rate increases the cost of imported oil, gas, food and industrial materials. For consumers, this can mean higher everyday prices, while companies that depend heavily on imported inputs face rising production costs.
This combination creates a difficult policy environment for the Bank of Japan. Weak consumption and modest economic growth argue for caution, while persistent inflation, high import costs and the weak yen strengthen the case for higher interest rates.
Financial markets increasingly expect further monetary tightening. The yield on Japan’s benchmark 10-year government bond reached around 2.925% on August 17, its highest level in roughly three decades, despite the weaker-than-expected GDP figures.
Investors are therefore looking beyond the headline growth number and focusing on inflationary risks and the possibility that the Bank of Japan could raise interest rates again. A higher policy rate could support the yen and help contain inflation, but it would also increase borrowing costs for households and companies.
The longer-term outlook remains one of moderate rather than rapid expansion. Japan’s government recently reduced its forecast for real GDP growth in the fiscal year ending March 2027 to 0.9%, down from the 1.3% predicted in January. Higher energy costs were an important reason for the downgrade.
The government also lowered its forecast for private consumption growth to 0.9% from 1.3%, while expected capital expenditure growth was reduced from 2.8% to 2.3%. At the same time, its inflation forecast was raised from 1.9% to 2.2%.
Much will therefore depend on wages. The government expects nominal wages to continue rising, but for households the crucial question is whether pay increases can consistently exceed inflation. If real incomes improve, consumer spending could become a stronger engine of economic growth.
If energy remains expensive, the yen stays weak and prices continue to rise faster than household purchasing power, consumers are likely to remain cautious. Japan could then continue expanding without achieving the stronger domestic-demand-driven recovery policymakers want.
The 1.1% annualised growth figure is therefore positive, but it tells only part of the story. The underlying quarterly increase was 0.3%, household consumption was essentially stagnant and business investment fell 1.2%. Japan is still growing, but the balance between economic expansion, inflation, wages, the weak yen and energy costs remains increasingly delicate.
