Japan’s GDP Revised to 2.3% Contraction in Q3 2025 as Tariffs Bite and BoJ Eyes Rate Hike

Deeper July–September slump raises questions about “Sanaenomics”, but markets still bet on a December rate increase.

TOKYO — December 8, 2025

Japan’s economy shrank more sharply than first reported in the July–September quarter, with revised figures showing an annualised 2.3% contraction, compared with an initial estimate of 1.8%. On a quarter‑on‑quarter basis, real GDP fell 0.6%, versus the preliminary 0.4% drop and slightly worse than economists’ median forecast of a 0.5% decline. ^[1]

The revision confirms Japan’s first GDP contraction in six quarters and the steepest fall since the third quarter of 2023, underscoring how new U.S. tariffs, weaker capital spending and regulatory changes in housing have combined to stall momentum after strong growth in the first half of 2025. ^[2]

Yet despite the deeper slump, most analysts still expect the Bank of Japan (BoJ) to raise its policy rate from 0.5% to 0.75% at its December 18–19 meeting, arguing that the contraction is largely a one‑off payback from earlier front‑loaded exports and housing activity, rather than the start of a recessionary spiral. ^[3]

What the revised GDP data show

The Cabinet Office’s second estimate paints a more fragile picture of Japan’s Q3 performance than the preliminary release in mid‑November: ^[4]

Annualised growth: –2.3% (revised from –1.8%)
Quarter‑on‑quarter real GDP: –0.6% (revised from –0.4%)
Fastest contraction: Since Q3 2023
First decline: After six consecutive quarters of growth

Breaking the quarter down by expenditure:

Private consumption (over half of GDP) was revised up, growing 0.2% quarter‑on‑quarter instead of 0.1%, reflecting slightly stronger spending on services such as dining out. ^[5]
Capital expenditure (capex), a key gauge of private‑sector demand, was revised sharply down, now showing a 0.2% decline instead of the previously reported 1.0% rise. Economists had expected a 0.4% increase, so the final number is a clear negative surprise. ^[6]
External demand (exports minus imports) shaved 0.2 percentage points off growth, unchanged from the initial estimate, as exports fell 1.2% while imports declined 0.4%. ^[7]
Domestic demand in total knocked 0.4 percentage points off GDP, double the 0.2‑point drag reported in the preliminary data. ^[8]
Housing investment contracted 8.2% on the quarter, still a severe drop but slightly less bad than the earlier –9.4% estimate. ^[9]

In short: consumption held up a little better than first thought, but the corporate and construction sides of the economy look materially weaker.

Tariffs, housing rules and capex: the main drags

U.S. tariffs hit exports

The revised data confirm that trade was a key drag on Q3. Exports fell 1.2% versus the previous quarter, reflecting the impact of new tariffs imposed by the administration of U.S. President Donald Trump on a wide range of Japanese goods, particularly autos. ^[10]

In September, Washington formalised a baseline 15% tariff on nearly all Japanese imports, replacing earlier plans to levy 27.5% on automobiles and 25% on most other products. ^[11]

Japanese exporters had rushed shipments in the first half of 2025 to beat the tariff deadline, helping Q2 GDP to grow at an annualised rate of around 2.2–2.3%. The Q3 contraction is therefore partly a “payback” quarter, with exports normalising from artificially elevated levels. ^[12]

To soften the blow and secure a deal that avoided even harsher duties, Tokyo pledged a massive package of U.S‑bound investments and loans worth about $550 billion, but the tariff shock is still weighing on trade volumes and corporate sentiment. ^[13]

Housing investment slumps after rule changes

Another major drag came from housing investment, which plunged 8.2% in Q3 as stricter energy‑efficiency and building‑code regulations that took effect in April continued to bite. Analysts say developers front‑loaded construction earlier in the year, then sharply reduced starts once the new standards kicked in, producing a deep slump in residential investment. ^[14]

Although the downward revision (from –9.4% to –8.2%) shows the decline wasn’t quite as steep as first feared, housing remains one of the largest drags on overall GDP.

Capex: from support to headwind

Perhaps the most worrying element in the revision is capital expenditure. Ministry of Finance survey data had already signalled that corporate investment was slowing: capex rose 2.9% year‑on‑year in July–September, down from 7.6% in Q2, and fell 1.4% on a seasonally adjusted quarterly basis. ^[15]

When those figures were incorporated into the national accounts, the GDP capex component flipped from a reported 1.0% increase to a 0.2% fall. Economists note that firms are still spending heavily on software, automation and AI‑related upgrades to cope with labour shortages, but the pace is clearly moderating as profits come under pressure from tariffs and weaker external demand. ^[16]

The revised capex data suggest that domestic private demand is less robust than previously thought—a key concern for policymakers hoping that investment would offset trade‑related weakness.

Consumers are still spending, but real incomes are squeezed

On the surface, Japanese households look surprisingly resilient. Private consumption grew 0.2% quarter‑on‑quarter in Q3, a touch stronger than the 0.1% originally reported and marking another quarter of positive spending despite high inflation. ^[17]

Underneath that, however, real wages remain under pressure. Government data show that: ^[18]

Inflation‑adjusted real wages fell 0.7% year‑on‑year in October, the 10th straight monthly decline.
Nominal cash earnings rose 2.6% to about ¥300,000 on average, but consumer prices increased by roughly 3.4%, eroding purchasing power.

Labour unions are pushing hard to reverse that squeeze. Japan’s largest union confederation, Rengo, is seeking pay hikes of 5% or more in the 2026 “shuntō” spring wage negotiations, similar to this year’s demands that produced the biggest wage rise in more than three decades. ^[19]

A November survey by the Japan Center for Economic Research found economists expect wage increases to average roughly 4.9% next year, with some private forecasters projecting hikes above 5% for a third consecutive year. ^[20]

That combination—modest consumption growth today but improving wage prospects—helps explain why many analysts view the Q3 GDP dip as a soft patch rather than a collapse in underlying demand.

Why markets still expect a BoJ rate hike

Under normal circumstances, a deeper‑than‑expected GDP contraction might argue for caution. But the market narrative around the Bank of Japan is almost the opposite: investors see the revised figures as insufficient to derail a near‑term rate hike.

Several strands of evidence point in the same direction:

A Reuters poll in late November found that 53% of economists expect the BoJ to raise its short‑term policy rate from 0.5% to 0.75% at the December 18–19 meeting, with all respondents predicting at least 0.75% by March 2026. ^[21]
Another Reuters report on November 26 said the BoJ is “prepping markets” for a near‑term move, with board members increasingly vocal about the need to normalise policy and government officials signalling they would tolerate a hike. ^[22]
Japanese and international media report that key government figures and the new administration of Prime Minister Sanae Takaichi have largely dropped resistance to a December hike, especially as a weak yen has pushed up imported inflation. ^[23]
Market pricing reflected in bond yields and derivatives now implies a high probability—often estimated around 80%—of a move to 0.75% this month. ^[24]

BoJ Governor Kazuo Ueda has repeatedly framed any upcoming hike as a gradual reduction in stimulus, not a shift to tight policy. The bank’s October Outlook Report projects modest but positive growth, with exports weighed down by tariffs and overseas weakness, but domestic demand supported by accommodative financial conditions, wage gains and fiscal measures. ^[25]

In other words, the central bank appears willing to look through a single negative quarter as long as the broader narrative—rising wages, above‑target inflation and a closing output gap—remains intact.

Takaichi’s ¥21.3 trillion stimulus: powerful backstop, rising risks

The GDP revision lands just weeks after Prime Minister Sanae Takaichi pushed through a ¥21.3 trillion (about $135 billion) stimulus package, her first major economic initiative since taking office. ^[26]

Key features of the package and associated extra budget include: ^[27]

Size and structure
- ¥17.7 trillion in general‑account spending—far above last year’s ¥13.9 trillion—and 2.7 trillion in tax cuts.
- Total package of 21.3 trillion yen, the largest since the COVID‑19 pandemic.
Financing
- An 18.3 trillion yen supplementary budget, mostly funded by 11.7 trillion yen in new government bonds, with the rest covered by stronger‑than‑expected tax revenues and non‑tax income.
- New bond issuance for the fiscal year is projected at 40.3 trillion yen, slightly below last year’s 42.1 trillion, as the government shifts more issuance to shorter‑dated maturities to avoid further pressure on long‑term yields.
Policy measures
- 2.7 trillion yen in tax cuts and 8.9 trillion yen in cost‑of‑living support, including cash handouts for children and subsidies for electricity and gas bills.
- 6.4 trillion yen for “strategic investments” in sectors such as semiconductors, shipbuilding and artificial intelligence.

Supporters argue that with tariffs biting and real wages still negative, aggressive fiscal support is necessary to prevent the Q3 slump from snowballing. Critics worry that the fiscal splurge—coming on top of a debt stock already around three times the size of GDP—could prove self‑defeating if it drives bond yields and risk premia higher, especially once the BoJ starts lifting rates. ^[28]

The revised GDP figures strengthen the political case for stimulus, but they also reinforce questions about how long Japan can lean on fiscal expansion if growth remains modest and borrowing costs drift upward.

How forecasters see Japan’s path from here

Despite the ugly Q3 headline, most major institutions still see positive, if subdued, growth for Japan over the next few years.

Near‑term rebound expectations

The initial GDP release in November (–1.8% annualised) prompted forecasts of a Q4 rebound, with private‑sector surveys compiled by the Japan Center for Economic Research pointing to quarterly growth of around 0.6% in the October–December period, as exports stabilise and fiscal support ramps up. ^[29]
The updated 2.3% contraction doesn’t fundamentally change that view, according to economists quoted by Reuters and other outlets, who still expect the slump to be largely temporary and driven by special factors such as front‑loaded exports and regulatory changes. ^[30]

2025–2027 growth and policy path

The IMF’s October World Economic Outlook raised its forecast for Japan’s real GDP growth in 2025 to 1.1%, with growth easing to 0.6% in 2026, supported by an expected pickup in real wages and robust consumption, even as tariffs and external weakness weigh on exports. It also envisages the BoJ gradually lifting its policy rate toward around 1.5% over the medium term. ^[31]
The OECD’s December Economic Outlook projects that after growing about 1.3% in 2025, Japan’s economy will slow to roughly 0.9% per year in 2026–27, with domestic demand as the main engine and U.S. tariffs providing a mild drag on trade. The report explicitly notes that wage gains and the new stimulus package should underpin consumption, investment and public spending. ^[32]
The BoJ’s own October Outlook Report describes a baseline scenario of modest growth: exports and business investment are expected to be held back by overseas slowdown and tariff effects in the near term, but overall growth is projected to gradually improve as global conditions stabilise, wage‑driven consumption firms and corporate investment in capacity and digitalisation continues. ^[33]
Private‑sector economists, including those cited in ING’s “Asia 2026: 5 questions for Japan’s year of ‘Sanaenomics’,” generally anticipate a “meaningful recovery” in 2026, driven by wage growth, fiscal support and targeted investment incentives—though they caution that excessive stimulus could unsettle markets or crowd out private activity. ^[34]

Taken together, the consensus is that Japan is not headed for a deep or prolonged recession, but rather a period of low‑single‑digit growth with elevated policy risk—particularly around tariffs, wages and the delicate coordination of fiscal and monetary tightening.

What the 2.3% contraction means for businesses, households and markets

For Japanese households

The Q3 data confirm that consumption is still growing, but only just. Combined with ten months of falling real wages, that suggests households are leaning on savings, government support and income from bonuses to maintain spending. ^[35]
The success—or failure—of the 2026 wage round will be crucial. If pay rises around 5% while inflation drifts back toward 2%, real incomes could finally turn decisively positive, reinforcing the BoJ’s confidence in rate normalisation and supporting a more durable consumption recovery. ^[36]

For companies

Export‑reliant manufacturers, especially automakers and metals producers, face a challenging mix of tariffs, soft external demand and rising wage expectations. Many have responded by cutting prices in the U.S. market to preserve share, which compresses margins. ^[37]
At the same time, firms are under structural pressure to keep investing in automation, AI and energy‑efficient infrastructure, which should sustain a baseline of capex even as cyclical conditions deteriorate. The Q3 revision shows that such investment is no longer enough to fully offset the drag from trade and housing, but surveys still point to relatively firm medium‑term capex plans. ^[38]

For markets and global investors

Japan’s super‑long government bond yields have already risen to multi‑year highs on expectations of BoJ tightening and concern over the size of Takaichi’s stimulus. A confirmed 2.3% GDP contraction complicates that picture: it strengthens the political justification for fiscal support, but also underscores the risk that fiscal and monetary policy will be tightening in opposite directions. ^[39]
The yen remains highly sensitive to the BoJ–Fed policy gap and tariff headlines. A December BoJ hike could offer some support, but if growth disappoints or U.S. policy stays looser than expected, currency weakness may persist. ^[40]

For now, the revised GDP data underline a simple reality: Japan’s recovery is intact but fragile. The economy is being squeezed from three sides—tariffs, higher living costs and a slow normalisation of interest rates—while relying heavily on government spending, corporate investment in productivity and a long‑promised era of stronger wage growth to carry it through.

Whether the July–September slump proves to be a short‑lived stumble or the start of a tougher phase for “Sanaenomics” will depend on decisions made in the coming weeks—above all at the Bank of Japan’s December meeting and in next year’s wage talks.