Japan's trade performance reached unprecedented levels in July, with imports surging 27.8% to a record 12.15 trillion yen ($77 billion) and exports rising 23.2% to 11.51 trillion yen ($73 billion), according to the latest government data. Both imports and exports reached the highest levels by value since comparable data became available in January 1979, as reported by the Finance Ministry. The trade deficit totalled 634.5 billion yen ($4 billion) last month, marking the third straight month of red ink. Strong auto exports to the US and healthy shipments of semiconductors and electronic devices drove the export growth, with Japan's exports now growing every month for almost a year. However, soaring energy costs and a weak yen have helped extend the trade deficit, as Japan imports almost all its oil and previously relied heavily on Middle Eastern supplies through the Strait of Hormuz, which remains effectively closed due to the Iran war.
Japan's economy grew slower than expected in the second quarter, with preliminary Q2 real GDP rising just 0.3% quarter-on-quarter, well short of the 0.5% forecast, as reported by Bloomberg. The annualised growth rate of 1.1% badly missed expectations of 2.0%, marking a step down from the previous quarter's upwardly revised 1.9% expansion. This marked the first full quarter to reflect the impact of the Iran war, which has driven up energy costs for businesses and households alike, complicating the Bank of Japan's efforts to communicate the timing of its next rate rise. Capital spending proved the biggest drag, contracting 1.2% during the quarter against forecasts for a 0.4% rise, and steeper than the previous period's 1% fall. Private consumption, which accounts for more than half of economic output, stagnated at 0.0% against expectations of a 0.5% increase as shoppers grappled with the rising cost of living. The GDP deflator rose 2.6% year-on-year, underscoring that price pressures remain elevated even as headline growth disappoints. However, Capital Economics analysts noted that "GDP expanded at a decent pace in Q2 and with the government still limiting the pass-through from higher energy prices," while a jump in government consumption suggests that Takaichi's expansionary fiscal policies are starting to have an impact. As per The Economic Times, consumption was affected by several temporary factors including earlier policy and regulatory changes that boosted demand for automobiles and air conditioners, while measures such as free education and higher tobacco prices weighed on overall household spending.
Escalating tensions in the Middle East and disruptions to tanker traffic through the Strait of Hormuz have kept oil prices elevated, adding to inflation concerns and pushing Japanese government bond yields to multi-decade highs, according to Reuters. The war in Iran has sent crude oil prices soaring, with Japan, which imports almost all its oil, previously relying heavily on oil imports from the Middle East through the Strait of Hormuz, which remains effectively closed. At the same time, the weak market breadth reflected concerns over Middle East tensions, inflation and rising bond yields, which added to the pressure on Japanese equities. Akiyama noted that weaker-than-expected GDP growth could indicate that inflationary pressures and a slowdown in the U.S. economy are beginning to weigh on Japan, as reported by Reuters. The 30-day correlation of changes in the Dollar Index and the US two-year yield is near 0.60, its highest in nearly two months, indicating the dollar's continued sensitivity to short-term interest rate changes. Fed funds futures are pricing an implied 66.9% probability that Fed policymakers will hold interest rates at their next two-day meeting ending on September 16, up from a 47.6% chance a month ago, as reported by the CME Group's FedWatch tool*. Rising import costs also pose a potential risk, with a weaker yen and higher crude oil prices potentially increasing costs for businesses and eventually leading to broader price increases for consumers later this year, according to The Economic Times.
Despite the overall weakness, exports offered a rare bright spot, with net external demand adding 0.5 percentage points to growth on the back of strong US demand for Japanese hybrid vehicles and continued global investment in artificial intelligence, which boosted shipments of semiconductor equipment as a weaker yen also aided shipments, according to CNBC TV18. The dollar sank to its weakest level since May as traders pared back expectations for a September rate move, while the Japanese yen held largely steady at 159.24 per dollar. External demand provided a stronger than expected 0.5 percentage point contribution to GDP, beating forecasts of 0.3 points, helped by a 0.5% rise in exports. Demand for AI-related infrastructure helped sustain shipments of semiconductor equipment and components, as reported by The Economic Times. Sequentially, retail sales look a little stronger, while industrial production, fixed asset investment, and property investment may have softened, according to recent market analysis. Investors are likely to continue monitoring developments in the Middle East, oil prices and Japanese bond yields, alongside upcoming economic data, for clues on the outlook for inflation, domestic demand and monetary policy.
The soft consumption figures could pose a fresh challenge for Prime Minister Sanae Takaichi, whose approval ratings have slipped roughly six months after a landslide election win, as voters contend with persistently high prices for everyday goods, as reported by CNBC TV18. Takaichi has already introduced subsidies to cap utility bills and plans to cut the sales tax on food to 1% for two years from April. Despite the weaker headline figures, traders were pricing in an 80% chance that the Bank of Japan would raise its benchmark rate at its next policy meeting on September 18, according to swaps market data cited by Bloomberg, with the central bank said to be weighing a faster pace of hikes than its usual twice a year system. However, a survey by the Japan Center for Economic Research showed that 37 economists expect annualised GDP growth to slow to an average of just 0.05% in the July-September quarter, as reported by The Economic Times. The latest figures therefore leave the Bank of Japan facing a delicate balance: inflation and wage gains could justify further policy tightening, but softer household spending and investment may encourage policymakers to proceed cautiously. Strong wage growth and government policy support are expected to support domestic demand, though the impact of the Middle East conflict remains a key risk for Japan's growth outlook. Analysts increasingly have said Prime Minister Takaichi's policies have had minimal effect so far in turning around Japan's economy, though she is likely to stay in power at least for the next several months as no election is scheduled and her popularity with voters remains relatively high.
