Japan’s 2Q GDP disappoints, but the equity story still has legs

• 2Q GDP disappointed: Real GDP grew 0.3% QoQ, below the 0.5% consensus and down from 0.5% in 1Q, with domestic demand losing momentum. Net exports contributed entirely to the quarterly growth.
  
  
• Domestic demand is likely to face increasing pressure: Private consumption and capital expenditure could remain weak in the months ahead as geopolitical uncertainty and rising costs weigh on corporate confidence, while higher input costs are increasingly passed on to households, squeezing purchasing power.
  
  
• AI exports remain a powerful offset: Strong global demand for semiconductors, AI infrastructure and automobiles supported double-digit YoY export growth, benefiting Japan’s technology and precision-equipment companies.
  
  
• BOJ rate hike remains on the table: We believe weaker growth alone is unlikely to derail monetary normalisation, given persistent inflation and yen weakness. However, softer consumption and capex could argue for a slower pace of tightening.
  
  
• Remain constructive on Japanese equities: We maintain our 3.0-star rating for Japan equities where corporate reforms and structural growth could continue to drive earnings and valuation upside.

Japan’s economy continued to expand in 2Q26, but the Cabinet Office’s preliminary estimate delivered a clear disappointment. Real GDP grew 0.3% quarter-on-quarter (QoQ), equivalent to a 1.1% annualised rate. While growth remained positive, it fell well short of market expectations for a 0.5% QoQ increase, or 2.0% annualised, and marked a slowdown from the 0.5% QoQ growth recorded in 1Q26.

2Q GDP: Net export did the heavy lifting while consumption softened

Net trade was the biggest contributor to growth, adding 0.5 percentage points to QoQ GDP growth (Table 1). Japan’s exports accelerated throughout the quarter on a year-on-year (YoY) basis, rising 14.8%, 16.8% and 19.3% from April to June respectively. Strong global demand for AI-related semiconductors and automobiles provided an important boost, while the weaker yen also supported the value of exports.

The domestic picture was considerably softer. Private consumption was flat QoQ, marking the weakest reading in eight quarters and falling short of expectations. This was particularly disappointing given that real wages have been staying positive for 1H2026, while retail sales and the Bank of Japan’s consumption activity index had pointed to a stronger quarter. In other words, the income recovery has yet to translate convincingly into household spending. Japanese consumers appear to be saving or rebuilding their balance sheets rather than fully passing higher incomes through to consumption.

Government consumption provided a bright spot, rising 1.6% QoQ, likely reflecting the flow-through of supplementary-budget spending under the Takaichi administration.

Business investment was the weakest link. Private non-residential investment fell 1.2% QoQ, worsening from a 1.0% decline in 1Q and sharply missing expectations for a 0.4% increase. This marks two consecutive quarters of declining capital expenditure and suggests Japanese corporates are becoming more cautious about the economic outlook amid persistent geopolitical tensions and uncertainty over external demand, despite relatively healthy profits and wage-setting trends in Japan.

Table 1: 2Q GDP breakdown

Driver	QoQ real growth	Contribution to GDP (pp)	Annualised
Real GDP	0.3%	-	1.1%
Net exports of goods & services	—	0.5	—
Exports of goods & services	0.5%	0.1	2.1%
Imports of goods & services	-1.5%	0.3	-6.0%
Domestic demand	-0.2%	-0.2	-0.7%
Private consumption	-0.0%	-0.0	-0.1%
Government consumption	1.6%	0.3	6.7%
Private non-residential investments	-1.2%	-0.2	-4.6%
Source: Cabinet Office. iFAST compilations. Data as of 30 June 2026.

What does 2Q GDP mean for Japan’s economy in 2H26?

The composition of 2Q GDP reinforces a concern we highlighted in our Japan 2H26 outlook: rising costs are becoming a more significant threat to household purchasing power. Higher energy and imported input costs, amplified by the weak yen, are putting increasing pressure on Japanese corporates. As companies gradually pass these costs on to consumers, household purchasing power could come under further strain. This was one of the key factors behind our decision to lower Japan’s equity rating from 3.5 to 3.0 stars.

Related article: Japan Outlook 2H26: Rally isn’t over – but the winners are shifting

The latest producer-price data provides further evidence that cost pressures are building. Japan’s PPI rose 7.2% YoY in July, broadly in line with June but significantly above the 5.4% and 6.6% increases recorded in April and May. The persistent growth suggests that corporate input costs have risen materially from the beginning of 3Q26, increasing the likelihood of further pass-through to consumers.

The latest GDP data should not be interpreted as a sign that Japan is heading towards contraction. On a YoY basis, real GDP growth actually accelerated to 0.7% in 2Q from 0.5% in 1Q. Private consumption also remained positive, rising 1.1% YoY. The QoQ figures therefore look more alarming than the broader trend suggests.

Our interpretation is that Japan’s economy is still expanding, but the pace is moderating as higher costs increasingly weigh on domestic demand. The key question for 2H26 is whether external demand — particularly AI and semiconductor-related exports — can continue to compensate for softer household consumption and corporate investment.

We believe it can, at least to some extent. AI-related demand remains a powerful external tailwind. Following their 2Q earnings results, major US hyperscalers raised their 2026 capital expenditure guidance. Amazon increased its forecast from USD200 billion to USD220 billion, while Alphabet raised its range to USD195–205 billion from USD180–190 billion. The continued expansion of global AI data-centre infrastructure and demand for advanced logic and memory chips should translate into sustained orders for Japanese semiconductor equipment and precision machinery companies.

This creates an important divergence within Japan’s economy. Domestic-facing sectors may face greater pressure from higher energy and input costs, while exporters and companies exposed to the global AI investment cycle could continue to benefit. We therefore expect 2H26 GDP growth to be weaker than 1H26, but still positive. The economy is likely losing some momentum rather than entering a downturn.

Another BOJ hike remains on track despite the weaker GDP print

The GDP data arrives at an important juncture for the Bank of Japan. The policy rate currently stands at 1.0% following the June hike, with the BOJ keeping rates unchanged in July. At its July meeting, the BOJ maintained a tightening bias and left open the possibility of another hike as early as September. At least one board member also argued for a faster pace of rate increases given the upside risks to inflation.

A weaker GDP print could, therefore, complicate the timing of the next hike — but we do not believe it derails the broader normalisation cycle.

As we highlighted in our previous updates, the key drivers of another hike are still inflation and yen weakness rather than headline GDP growth. Core inflation is moving steadily towards BOJ’s 2% target, while a weak yen continues to raise imported inflation pressures.

Importantly, the BOJ has already lowered its FY2026 real GDP growth forecast to 0.6% at its July meeting, from 1.0% in January. In other words, policymakers have already incorporated a weaker growth outlook into their projections. Unless the economy deteriorates into a much more severe downturn, softer GDP growth alone is unlikely to prevent further monetary normalisation.

What the latest GDP figures could change is the pace, rather than the direction, of tightening. Private consumption and capital expenditure remain critical to the sustainable, domestic-demand-led expansion that the BOJ wants to see. With both components currently showing weakness, the case for larger rate increases or a faster tightening cycle becomes less compelling.

We therefore continue to expect further policy normalisation but see a greater likelihood of a gradual approach rather than an aggressive hiking cycle. A meaningful rebound in consumption or capex would be the key signal that could revive the case for a quicker tightening cycle.

Japan equities: Structural themes remain intact

Despite the softer GDP data, we remain constructive on Japan’s longer-term equity story and maintain our 3.0 star rating.

The investment case is increasingly driven by structural rather than cyclical factors. Corporate governance reforms still have significant room to run, AI-related earnings growth remains a powerful structural theme, and gradual monetary normalisation could eventually support a stronger yen and improve the quality of foreign capital inflows.

The Nikkei 225 closed higher on 17 August despite the disappointing GDP release. The index has become increasingly exposed to global AI and semiconductor investment through major constituents such as Advantest, Tokyo Electron, SoftBank Group, Ibiden and Kioxia. As a result, its earnings outlook is increasingly influenced by global technology spending rather than Japanese household consumption alone.

The Nikkei 225 is expected to reach JPY76,820 by FY2028, representing 16.0% upside from current levels. Investors seeking broad exposure to Japan’s equity growth can consider the Xtrackers Nikkei 225 UCITS ETF 1D (LSE: XDJP). For investors seeking a more active approach, Eastspring Investments - Japan Dynamic AS SGD and Amova Japan Equity SGD offer exposure to undervalued Japanese companies that could benefit from ongoing corporate governance reforms. Amova Japan Equity has a more distinct tilt towards companies positioned to capture Japan’s structural automation and industrial manufacturing expansion.

We are also positive on Japanese small caps, which have yet to fully participate in the valuation re-rating that has benefited larger Japanese companies. However, the investment environment is becoming more challenging as wages, energy and other operating costs rise. Investors should therefore be selective rather than taking broad exposure to the small-cap segment. As such, we favour an active approach to Japanese small caps, with strategies such as Janus Henderson Horizon Japanese Smaller Companies A2 USD and BNP Paribas Japan Small Cap Classic Cap SGD.

For investors, the message is therefore less about stepping away from Japan and more about being selective about where the next leg of the rally comes from.

Declaration:

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.