Japan's GDP shrank for the first time in six quarters, with a decline smaller than expected, and the 10-year Japanese government bond yield hit a 17-year high

Due to weak domestic demand and the impact of U.S. tariffs, Japan's economy contracted in the third quarter, but the contraction was smaller than economists' general expectations, mainly thanks to stable corporate capital expenditure helping to offset weak private consumption. This report highlights the fragility of Japan's economic recovery and may complicate the Bank of Japan's policy path.

On Monday, November 17, the latest data released by the Japanese government showed that Japan's GDP contracted at an annualized rate of 1.8% in the third quarter, better than the market expectation of a 2.5% decline, but a stark reversal from the 1.6% growth in the second quarter. On a quarter-on-quarter basis, GDP shrank by 0.4%, also better than the expected -0.6%, while the previous quarter's growth was 0.5%.

The key driving factors behind this economic contraction are the simultaneous slowdown of both domestic and external demand engines. Private consumption, which accounts for about half of the economy, saw almost no growth, while the global economic slowdown and trade tensions caused net exports to become a drag on economic growth.

Following the release of this data, market expectations for the Bank of Japan to raise interest rates soon have cooled. Investors and analysts are turning their attention to the fiscal stimulus plan that newly appointed Prime Minister Sanna Takagi may introduce to support the weak economy.

After the GDP data was released today, the USD/JPY exchange rate rose by 0.01%, currently reported at 154.56.

Japan's 10-year government bond yield rose by 2 basis points to 1.720%, the highest level since June 2008.

Capital expenditure becomes an unexpected highlight, as internal and external demand engines stall simultaneously

Despite the overall economy facing headwinds, corporate investment has shown resilience, becoming a rare highlight in this data. Capital expenditure grew by 1.0% quarter-on-quarter in the third quarter, far exceeding the market consensus expectation of 0.3%.

Data shows that despite weak external demand, large Japanese companies continue to increase capital expenditure, particularly in strengthening local infrastructure. Strong corporate investment helped offset weak performance in other areas of the economy, providing crucial support for GDP data and avoiding a larger decline.

However, the strong performance of capital expenditure cannot mask the dual dilemma facing Japan's economy: sluggish internal consumption and weak external demand. Data shows that domestic and external demand each contributed a 0.2 percentage point drag on GDP growth in the third quarter.

Internally, private consumption, the most important pillar of the economy, only increased by 0.1%, in line with expectations. The report noted that persistent inflation and weak wage growth have suppressed household spending willingness, and consumer sentiment remains cautious. Externally, as global economic growth slows, coupled with the ongoing impact of U.S. trade tariffs and other trade frictions, Japan's exports fell by 1.2% quarter-on-quarter in the third quarter, leading to a drag on economic growth from net exports

Policy Outlook Adds Uncertainty

This complex economic report poses challenges for Japanese policymakers. On one hand, the data shows persistent inflationary pressures, with the GDP deflator rising 2.8% year-on-year in the third quarter, in line with expectations, providing justification for the Bank of Japan to consider policy normalization.

However, on the other hand, the economy itself has shifted into contraction, limiting the central bank's room to adopt tightening policies. According to Reuters, traders have generally reduced their bets on the Bank of Japan raising interest rates in the short term, partly due to limited economic strength and potential political resistance. As a result, the market's focus is increasingly shifting towards fiscal policy, paying attention to whether the new government will stimulate the economy through increased fiscal spending.

According to Japanese media reports, Prime Minister Sanae Takaichi is expected to announce an economic revitalization plan of up to 17 trillion yen as early as this week to address sluggish economic growth. However, analysts point out that this move will further exacerbate the already high debt problem of the Japanese government.

In terms of monetary policy, the stagnation of economic growth makes the task of the Bank of Japan in promoting policy normalization even more challenging. Analysts believe that the uncertainty surrounding the economic outlook will inevitably delay the Bank of Japan's timetable for achieving monetary policy normalization