–Government to Watch Drag from Powerful Earthquake That Hit Southwestern Region Last Month as Well as Inflationary Effects of Middle East Conflict
By Max Sato
(MaceNews) – Japan’s government continued to project moderate economic recovery will continue in the near term, downplaying lackluster GDP growth in the April-June quarter, but also warned that high energy costs amid the Iran war could push up overall inflation and that last month’s deadly earthquake in the southwestern region could dampen growth.
In its monthly report for August released Thursday by the Cabinet Office, the government maintained its overview, saying that the economy is “recovering at a moderate pace but the impact of the situation in the Middle East and natural disasters needs a close attention.”
As for the near-term outlook, the government repeated, “The improvement in the employment and income conditions and the effects of various (fiscal) policies are expected to support a moderate recovery while the impact of the situation in the Middle East and natural disasters needs a close watch.”
The GDP data released this month showed the economy posted its third straight quarterly growth in the April-June quarter but it was much slower than expected as private consumption, business investment and public works spending all unexpectedly slipped. Energy and transportation costs remained elevated amid the lingering Mideast conflict and the weak yen kept import prices high.
The gross domestic product grew a modest 0.3% on quarter, or an annualized 1.1%, slowing from a 0.5% increase (the annual rate was revised to 1.9% from 1.8%) in the first three months of the year. All of the Q2 growth came from external demand but that was a result of a 1.5% plunge in imports after the blockade of the Strait of Hormuz led to a sharp decline in crude oil imports from the Mideast Gulf. Exports showed some resilience, up 0.5%, as the drag from stiff U.S. tariffs on autos and metals had waned.
Private consumption, which accounts for about 55% of total domestic output, came in nearly flat, down 0.0% on quarter (consensus +0.5%), marking its first drop in eight quarters after showing a solid 0.5% gain in Q1. Business investment in equipment and software slumped 1.2% (consensus +0.4%) after falling a downwardly revised 1.0% previously, indicating that some firms turned more cautious and the Iran war caused supply chain constraints. Public investment also disappointed, slipping 0.1% (consensus +0.6%), following a 1.5% rebound in the prior quarter.
In the monthly report, the government pointed to the bright side of the data, saying final demand rose 2.1% at an annualized pace in Q2 following a 2.3% gain in Q1. It also noted that lower school lunch fees that households paid contributed to the slight drop in private consumption but it was offset by higher government spending on school lunches. A transfer of large-scale patent rights overseas resulted in lower capital spending at home but that was counted as an increase in exports, it said.
On the downside, the government noted that high energy and import costs amid the lingering Mideast conflict are making Japan’s terms of trade worse by draining national wealth out to oil producers.
The powerful 7.1-magnitude earthquake shook Kumamoto Prefecture in southwestern Japan on July 28, killing 38 people and injuring many more while tearing roads and bridges and cutting off electricity and water supply. Some households still don’t have running water and others only limited hours of supply. More than 2,600 people are living at evacuation sites. The massive jolt led automakers like Toyota and Honda and chipmakers including Renesas and Tokyo Electron to suspend production in the region for a few days.
The disaster is expected to have a negative impact on industrial production and retail sales data for July to be released on Aug. 31.
The monthly Economy Watchers Survey, which was conducted by the Cabinet Office from July 25 to July 31 and released on Aug. 10, indicated that confidence continued to improve moderately as hot weather boosted demand for air conditioners and other seasonal goods. Some easing in price hikes caused by the Mideast conflict amid summer holidays also supported tourism. But at the same time, consumers remain wary of spending amid elevated costs and the life-threatening heat wave kept many people indoors during the daytime. The Kumamoto earthquake has also caused hotel booking cancellations in the Kyushu region.
The Watchers’ sentiment index showing the direction of Japan’s current economic climate rose to a five-month high of 45.7 in July on a seasonally adjusted basis, posting the third straight rise after rising to 44.0 in June from 43.6 in May. Before the impact of the Iran war emerged, the index climbed to a nearly two-year high of 48.9 in February from 47.6 in January. The last time the index was above the neutral line of 50 was in March 2024, when it stood at 50.1.
Looking ahead, the five-day long weekend in September and solid demand by visitors from overseas who are taking advantage of the weak yen propped up confidence among the tourism and leisure industries while the lingering U.S.-Iran dispute is making the outlook uncertain and prompting some firms to continue raising sales prices. Some respondents are also concerned that the damage inflicted by the earthquake will reduce production and new orders from the affected areas.
The Watchers’ outlook index, which shows sentiment in two to three months, marked its fourth straight increase but edged up just 0.1 point to 45.8 in July after making a clear gain to 45.7 in June from 40.7 in May. The index started the year at 50.1 before slipping to 50.0 in February and plunging to 38.7 in March.
To support consumer confidence and spending, the government is providing temporary subsides for electricity and natural gas to help curb utility bills from July through September when extreme summer weather is expected to boost the usage of air conditioners across the country. It has also kept a lid on retail prices of gasoline and other fuels by applying subsides since mid-March in light of the Iran war and scrapping the decades-old gasoline surcharge at the end of 2026. The government plans to keep the fuel subsidies for now.
The government maintained its core assessment of global growth. “The world economy continues to show gradual recovery while some regions are showing weakness,” it said, “However, the uncertainty over the global economy including the situation in the Middle East continues.”
Japan sees the U.S. economy as “expanding moderately” after upgrading its view for the first time in more than two years in the June report. The official views are unchanged for the Eurozone, which is “showing signs of a pickup” and for China that is still “slowing gradually.”
Key points from the monthly report:
The government maintained its core assessment of private consumption that accounts for about 55% of the GDP, saying that it is “showing signs of a pickup.”
Real average household spending posted the seventh straight year-on-year drop in June, down 3.3% (consensus +0.1%) after a slight 0.4% dip in May, as consumers paid less for health insurance premiums, airfares and gasoline. Typhoon weather and lower temperatures compared to a year earlier also dampened sales of clothing and appliances including air conditioners. The decrease was partly offset by home maintenance and repairs as well as the recent widespread markups in private university tuition fees.
Autos and related items, a widely fluctuating category, pushed down overall spending by 0.34 percentage point after trimming May expenditures by 2.30 points. Excluding home maintenance and repairs and other volatile items like vehicles and gift money, the core measure fell 4.3% (down 2.5% in nominal terms) after rising 2.6% (up a nominal 4.3%) the prior month.
The seasonally adjusted expenditures index plunged 6.4% on the month (consensus -3.7%) to 95.2 after surging 3.7% to a 12-month high of 101.7 in May and rising 1.6% to 98.1 in April.
The government also maintained its assessment of exports after upgrading it for the first time in 16 months in June, saying they “have shown signs of a pickup.”
Trade data released last week showed Japanese export values surged 23.2% on the year to a record high of ¥11.52 trillion in July for the 11th straight gain, surpassing the previous high of ¥10.98 trillion reached in March 2026, as the auto industry has weathered the drag from stiff U.S. tariffs and global demand for memory chips and non-ferrous metals remains strong. The increase was led by automobiles, computer chips and semiconductor-producing equipment, largely as seen in recent months.
Import values rose 27.8% for the sixth straight increase, hitting yet another record high at ¥12.15 trillion and exceeding the previous high level of ¥11.34 trillion seen the previous month, as the weak yen has eroded Japan’s purchasing power and the lingering Mideast conflict kept energy and transportation costs elevated. The increase was driven by crude oil, computer chips and non-ferrous metals, as seen in June. This resulted in a third straight trade deficit for Japan, with the shortfall widening sharply to ¥634.5 billion from a revised ¥409.93 billion deficit in June.
The government continues to describe industrial production as being “flat.”
Japan’s industrial production posted its third straight rise in June, up a solid 1.3% on the month (consensus +0.5%), led by strong global demand for semiconductor-producing equipment and a pickup in the auto sector as the base effect of stiff U.S. tariffs on vehicles and metals has waned. The increase follows a downwardly revised slight 0.1% gain in May and a 0.5% rebound on a 0.4% dip in March. Overall, it reflects solid global demand for computer chips and non-ferrous metals amid the artificial intelligence boom as well as a pickup in shipments of vehicles to the key U.S. market.
Last month, the monthly survey by the Ministry of Economy, Trade and Industry indicated that output would dip 0.7% on the month in July (adjusted for the statistics’ upward bias) before rebounding 4.5% in August.
Other details:
The government’s assessment of key components of the economy in the monthly economic report:
Private consumption is “showing signs of a pickup but softer consumer sentiment needs a close watch” (unchanged; upgraded in September 2025; downgraded in February 2024).
Business investment in equipment and software is “picking up” (unchanged; upgraded in April 2026; downgraded in November 2023).
Housing construction “is largely flat” vs. “has a weak undertone” (the first upgrade in 24 months; last upgraded in August 2024; downgraded in August 2025).
Public investment is “solid” (unchanged: upgraded in April 2026; downgraded in December 2025).
Exports are “largely flat” (unchanged; upgraded in June 2026; downgraded in July 2025).
Imports are “largely flat” (unchanged; upgraded in May 2025; downgraded in November 2025).
Industrial production is “flat” (unchanged; upgraded in May 2024; downgraded in Oct 2024).
Corporate profits are “improving but the Mideast situation needs a close watch” vs. “showing signs of improvement but the Mideast situation needs a close watch” (the first upgrade in six months; last upgraded in February 2026; downgraded in August 2025).
Business sentiment is “largely flat but firms are cautious about their outlook and thus the situation in the Middle East needs a close watch” (unchanged; upgraded in December 2023; downgraded in April 2025).
The pace of increase in bankruptcies is “largely flat” (unchanged; upgraded in June 2026; downgraded in October 2025).
Employment conditions are “showing signs of improvement” (unchanged; upgraded in June 2023; downgraded in May 2020).
Domestic corporate goods prices are “showing a slower pace of increase” vs. “rising” (wording changed; last changed in May 2025).
Consumer prices are “rising moderately” (unchanged; wording last changed in March 2026).