Japan's Surprising Economic Slowdown Threatens BoJ Rate Hike

Japan's economic growth slowed unexpectedly in Q2, with GDP increasing by just 0.3% month-on-month, down from 0.5% in the previous three months. The annualized expansion rate was also lower than expected, coming in at 1.1%, compared to forecasts of 2.0% and 1.9%. This unexpected slowdown has muddied the waters for a potential Bank of Japan (BoJ) interest rate hike, which had been widely anticipated due to accelerating inflation.

The weaker-than-expected growth was accompanied by a decline in capital expenditure and flat private consumption, which missed market expectations. The BoJ had been expected to raise interest rates soon as inflation accelerates in the world's fourth-largest economy. However, Taro Kimura at Bloomberg Economics said Monday's figures 'weaken the case' for a September increase.

A rate hike could lift the yen, which has given up around half of its gains following a historic joint market intervention by the US and Japan last month. The weak yen is beneficial to big Japanese exporters, but it also makes imports more expensive due to higher oil prices, which have swollen the country's import bill.

The government's expansionary fiscal policies are starting to show signs of impact, with nominal government consumption increasing by 5.4% annually, the largest since 2021. However, these efforts come at a cost, with the government expected to lose 10 trillion yen (US$63 billion) in lost tax revenues over two years due to slashing the consumption tax on food products from 8% to 1%.