Japan’s economy shrank in the July to September period, marking its first contraction in a year and reflecting the combined pressure of U.S. tariffs, weak exports and a steep downturn in residential investment. Government data released Monday showed an annualized decline of 1.8 percent, with GDP slipping 0.4 percent from the previous quarter.
The contraction follows moderate growth earlier in the year. The economy expanded 0.6 percent in the April to June quarter and 0.2 percent in the first quarter, but momentum faded as global demand softened and trade frictions intensified.
Exports slump under U.S. tariff pressure
Exports fell 4.5 percent in annual terms during the July to September window. Much of the weakness stems from the 15 percent tariff surcharge that the United States now applies to most Japanese imports, a policy rolled out under President Donald Trump. Automakers and industrial manufacturers, traditionally the engine of Japan’s export sector, have been especially affected despite efforts to shift more production offshore.
Earlier export data had appeared stronger, but analysts noted that many companies front-loaded shipments to beat tariff increases, temporarily inflating results. Imports were largely unchanged, slipping 0.1 percent, while private consumption managed a minimal 0.1 percent increase.
Residential investment plunges after building code overhaul
The most striking drag came from private residential investment, which recorded a 9.4 percent quarter-on-quarter decline, equivalent to a 32.5 percent annualized drop. Analysts attribute the fall to new building code requirements that took effect in April. The regulatory changes prompted a sharp slowdown in housing starts, disrupting construction activity and weighing heavily on overall GDP.
Japan’s reliance on housing and export-driven industries makes it particularly vulnerable to swings in global demand and policy changes abroad. The tariff environment adds another layer of uncertainty for manufacturers already facing supply chain adjustments.
Policy outlook and prospects for recovery
Prime Minister Sanae Takaichi, who assumed office in October, has pledged to revive economic growth through increased government spending and supportive fiscal policies. Such measures could, however, complicate the Bank of Japan’s attempts to control inflation. The central bank has been preparing to gradually raise interest rates from their longstanding near-zero levels.
The weak third-quarter performance makes a December rate hike unlikely, according to Marcel Thieliant of Capital Economics. Still, business sentiment surveys and early fourth-quarter indicators point to a potential rebound. If conditions stabilize, the Bank of Japan may resume rate increases early in 2026.
For now, Japan faces a delicate balance: cushioning the impact of external tariff shocks while managing structural reforms at home. The coming months will show whether stimulus efforts can offset trade headwinds and restore momentum to the world’s fourth-largest economy.
