What’s the verdict on Japan’s economy for 2025?

Japan’s economy was supposed to stumble in 2025. Most forecasts pointed to slowing growth and a monetary policy that was going nowhere.

In the meantime, trade wars, surging food prices, and political instability gave investors every reason to expect another lost year.

But despite all that chatter, the data points to a different story.

Growth has been stronger than feared, wages are starting to move, and households continue to spend.

The message right now is that Japan’s economy is harder to break than many assumed, but the path ahead depends on politics as much as economics.

Growth that defies the tariff shock

Revised figures confirm that Japan’s economy expanded at an annualized pace of 2.2% in the second quarter, double the government’s initial estimate of 1.0%.

Impressively, the economy has now grown for five consecutive quarters, a stretch not seen in years.

Household consumption continues to rise, and is even stronger than initial forecasts, while business investment advanced 0.6% in Q2.

Net exports added 0.3 percentage point to growth, partly because shipments were front-loaded before new US tariffs took effect.

These numbers are starting to change the narrative.

Earlier this year, headline GDP suggested a small contraction in the first quarter. That fed fears that inflation and tariffs were biting harder than expected.

Subsequent revisions show that the slowdown was exaggerated. And although Japan is not booming, the economy is proving more resilient than investors assumed at the start of the year.

The near-term outlook is less upbeat. Analysts expect a technical pullback in the third quarter as the export front-loading unwinds and new construction rules slow residential investment.

Forecasts point to a 0.3% quarterly contraction before growth stabilizes in the final months of the year.

For 2025 as a whole, most projections now sit around 1.0–1.2% real GDP growth, a pace that avoids recession but remains modest compared with other advanced economies.

Wages and spending: the cycle investors wanted

The tight labor market is the backbone of Japan’s current expansion.

The unemployment rate is currently 2.5%, and labor force participation has climbed to its highest level since the late 1990s.

Employers face structural shortages, pushing them to offer higher hourly pay even as overall hours worked continue to decline.

This year’s spring wage negotiations delivered an average 5.3% increase, the strongest since the 1990s.

The headline figure overstated reality in the first half of the year, with total cash earnings up just 1% in May and real wages still negative.

But more recent data show momentum.

Nominal wages rose in July at the fastest pace in seven months. Real wages edged into positive territory as food and energy inflation cooled.

This is the cycle the Bank of Japan has been trying to engineer: higher wages, more consumption, and moderate inflation.

It remains fragile, and the pressure on corporate margins from tariffs is a risk.

Auto exporters have been cutting prices in the United States to defend market share, sacrificing profitability.

Manufacturers’ pretax profit fell 11.5% year on year in the second quarter, with transport equipment earnings down nearly 30%.

That squeeze could limit the size of next year’s wage offers. But for now, consumer demand is holding, and that is keeping the economy afloat.

Inflation is cooling, but services are the wild card

Headline inflation has slowed from 4% in January to around 3.5% in May and even further to 3.1% in August.

Food prices remain high, with rice more than doubling from a year earlier, but broader food inflation has started to fall.

Core inflation, which strips out food and fuel, stood at 3.4% in August but remains controlled.

That gives the Bank of Japan confidence that headline inflation will fall back to its 2% target in fiscal 2025–26.

But the risk lies in services. As food prices ease and real incomes improve, demand for services could push those prices higher.

All three of the BoJ’s internal inflation measures, the trimmed mean, median, and mode, have been rising since spring, though two remain below 2%. Inflation expectations are creeping higher as well.

That combination is why the central bank still sees room to raise interest rates this year, even as political uncertainty clouds the outlook.

Trade headwinds: America and China bite hard

Trade remains the weak spot. Japan struck a deal with the US in July that cut tariffs on autos to 15% from the previous 27.5% and eliminated stacked tariffs.

That was progress, but not a fix. Exports to the US fell 10.1% in July from a year earlier, with vehicle shipments down 28% and auto parts down 17%.

At the same time, exports to China dropped 8.8% in May, the third monthly fall in a row, as China’s domestic car production surged. Exports to the European Union rebounded modestly, while shipments to ASEAN economies were flat.

The drag from trade is more than numbers. It is hitting profitability, and profitability is what finances wage growth and capital expenditure.

If tariffs stay in place into 2026, Japan will need stronger domestic demand to offset the lost external income.

That raises the stakes for fiscal policy and household confidence.

Politics: the real risk for investors

Prime Minister Shigeru Ishiba’s resignation on September 7 has added a new layer of uncertainty. His Liberal Democratic Party has lost its majority in both houses, and a leadership election in October will decide the country’s next direction.

The contenders within the LDP differ in their approach. One favors fiscal expansion and a softer monetary stance, while another emphasizes structural reforms and neutrality on the BoJ’s normalization path.

Either way, the lack of parliamentary majority makes bold policy changes unlikely.

Markets reacted quickly to Ishiba’s exit, with the yen weakening and government bond futures rising. Concerns over Japan’s fiscal position are never far away.

According to Ryoji Musha, the national burden rate has risen from 38% in 2011 to 48% today. Some opposition parties are calling for tax cuts to ease the pressure on households.

That could support consumption but would alarm bond investors already focused on Japan’s massive public debt. The political outcome is significant because it will set the fiscal backdrop for the wage-price cycle.

Relief that helps households without spooking markets would be the sweet spot. Anything else risks either undercutting demand or triggering higher yields.

The Bank of Japan’s dilemma

The Bank of Japan is caught between solid data and political risk. Before Ishiba’s resignation, markets were pricing a 70% chance of a rate hike by year-end. After Ishiba’s resignation, those odds dropped to around 40%.

Policymakers insist that if their growth and inflation forecasts hold, rates will rise. The second-quarter data supports that case: growth is solid, wages are up, and inflation remains above 2%. Yet the optics of tightening during a political transition are awkward.

Most economists expect no change at the September 19 policy meeting. October remains in play, but the risks of delay have grown.

Investors should expect the BoJ to remain extremely cautious in its communication, moving gradually and stressing data dependence.

The more political noise grows, the more likely the central bank is to push decisions into late 2025.

What investors should watch next

For investors, the key is not whether Japan posts 1% growth or 1.2% this year.

The real test is whether the wage-price cycle holds through the winter and into the 2026 wage negotiations.

If firms, even under margin pressure, continue to deliver pay rises that outpace inflation, consumption will remain strong enough to offset trade weakness.

Three signposts matter most.

First, wage and household spending data through autumn.

Second, export performance outside the US, especially in Europe and Southeast Asia.

Third, the composition of fiscal relief measures after the LDP leadership contest.

Together, they will decide whether the Bank of Japan delivers its first hike in years this October or waits until stability returns.

Japan’s economy in 2025 is not the fragile story it once was. It is not roaring, but it is resilient. The risk now lies less in the data and more in the politics.

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