Japan's economy shrinks in the first quarter, dragged by US tariff tensions

The Japanese economy took a hit for the first time in a year, weighed down by fragile domestic demand and trade tensions with the US. Preliminary government data released on Friday showed that the gross domestic product (GDP) fell at an annualised rate of 0.7% in the January-March quarter, significantly worse than the market’s forecast for a 0.2% drop. On a quarterly basis, GDP contracted 0.2%, double the expected 0.1% decline.

The downturn was largely driven by flat private consumption, which makes up more than half of Japan's economic output, and a sharp drop in exports indicating that the economy was losing support from external demand even before US President Donald Trump announced reciprocal tariffs on April 2.

According to a Reuters report, analysts warned that the situation could worsen once the full impact of tariffs imposed by US President Donald Trump begins to bite.

“Japan’s economy lacks a driver of growth given weakness in exports and consumption. It’s very vulnerable to shocks such as one from Trump tariffs,” said Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute.

“The data may lead to growing calls for bigger fiscal spending,” he added, warning that another contraction in the second quarter cannot be ruled out.

While there were some bright spots like capital spending rising by 1.4%, and fourth-quarter GDP growth being revised up slightly to 2.4% external demand was a major drag. Exports fell by 0.6% while imports rose 2.9%, shaving 0.8 percentage point off growth.

The GDP deflator rose 3.3% year-on-year, showing that companies are passing on rising costs. Still, that hasn’t been enough to lift overall momentum, especially as uncertainty looms over Japan’s key automobile sector, a major export engine.

Japanese automakers are already feeling the pressure amid uncertain trade tensions. Toyota expected its profit to drop by a fifth in the current financial year. US President Trump announced a 10% tariff on all countries except for Canada, Mexico and China alongside higher tariffs for big trading partners like 24% for Japan. These tariffs are said to take effect from July unless the countries can manage to negotiate a deal with Washington.

Japan's economic revitalisation minister Ryosei Akazawa acknowledged the challenges ahead, noting that wage growth could provide some support but trade risks remained a serious concern.

“We must be mindful of downside risks to the economy from US tariff policy. The hit to consumption and household sentiment from continued price rises is also a risk to growth,” Akazawa said during a press conference, quoted by Reuters.

“The early-year contraction serves as a reminder of Japan’s economic struggles. Tariff pain and weak domestic momentum will weigh on growth in the quarters ahead,” said Stefan Angrick, head of Japan and Frontier Markets Economics at Moody’s Analytics.

The weaker data is likely to increase political pressure on Prime Minister Shigeru Ishiba to introduce fresh stimulus or tax cuts, though Akazawa insisted no such measures are currently planned.

At the same time, the Bank of Japan is navigating its own set of complications. Having raised interest rates to 0.5% in January after ending a decade of ultra-loose policy, the central bank is now under pressure to hold back on further hikes. In early May, it slashed its growth forecasts, citing fears of a global slowdown.

Takeshi Minami, chief economist at Norinchukin Research Institute, said, “If the impact of Trump tariffs is fairly light, the BOJ could raise interest rates again in September or October. But if the tariffs deal a severe blow to capital spending and exports, rate hikes could be put on hold.”