Japan’s Growth Falters as Yen and War Risks Rise

Japan’s Economy Loses Momentum as Yen Pressures and Middle East War Cloud Outlook

Japan’s economy slowed more than expected in the second quarter, a setback that is sharpening concerns about the country’s resilience just as its most important exporters confront a painful mix of geopolitical turmoil, higher energy and shipping costs, and renewed volatility in the yen.

Government data released Monday showed that Japan’s real gross domestic product grew 0.3 percent from the previous quarter in April through June, or 1.1 percent on an annualized basis. Economists had been expecting growth closer to 2 percent. The latest reading was also a step down from the 1.8 percent annualized pace recorded in the first quarter after revision, suggesting that momentum is fading rather than recovering.

Beneath the headline figure, the details were weak. Private consumption was flat, an indication that households are still struggling to turn wage gains into stronger spending. Business investment also declined, underscoring caution among companies even as export sectors continue to provide some support.

That softer domestic backdrop matters because Japan is now entering a more precarious stretch. The country remains highly exposed to imported energy costs, and the war involving Iran has disrupted shipping routes and raised freight and input prices. At the same time, the foreign-exchange market is again testing the authorities’ ability to defend the yen after a rare joint intervention with the United States earlier this month.

A Difficult Mix for Carmakers

Few industries capture Japan’s predicament more clearly than autos.

Automakers have already been hit by the fallout from the conflict in the Middle East, which has driven up logistics costs and disrupted trade flows to a key export market. Earlier reporting this year showed that Japan’s vehicle exports to the Middle East were nearly wiped out in April as the conflict intensified. Toyota has estimated that war-related costs could reduce earnings by 670 billion yen this fiscal year.

Now carmakers face a second risk: a stronger yen.

For years, a weak currency has helped Japanese exporters by inflating the value of overseas earnings when converted back into yen. But any sustained rebound in the currency, particularly if driven by official intervention, would have the opposite effect, shrinking repatriated profits just as companies are coping with higher raw-material, energy and transport bills.

The result is a narrow and uncomfortable path. A weaker yen raises Japan’s import costs, especially for fuel, feeding inflation pressure at home. A stronger yen would ease some of that burden but could cut into exporter earnings. For manufacturers already squeezed by war-related disruptions, neither outcome offers much relief.

Intervention Buys Time, Not Certainty

The pressure on policymakers has been building since the yen slid to multi-decade lows near 163 to 164 against the dollar in late July, a move driven largely by the wide gap between U.S. and Japanese interest rates, as well as fears that the Iran conflict would push up oil prices.

On Aug. 1, Tokyo and Washington stepped into the market in a rare joint yen-buying operation, the first such coordinated intervention since 2011. The move briefly strengthened the currency and signaled a higher level of concern in both capitals about disorderly market moves.

But the effect has already begun to fade. Market analysts have remained skeptical that intervention alone can reverse the yen’s broader weakness as long as the Bank of Japan remains much more cautious on interest rates than the Federal Reserve. Without a narrower rate gap — or a more clearly hawkish turn from the BOJ — traders may continue to test how far Japanese authorities are willing to go.

That leaves Japan in an awkward policy bind. Officials want to prevent a sharp yen slide because it makes imports more expensive and hits households through energy and food prices. Yet repeated intervention is costly and, many investors believe, difficult to sustain if the underlying policy mismatch remains unchanged.

Why the Slowdown Matters Now

For much of the past year, Japan’s export performance has masked softness at home. But the second-quarter data suggest the buffer may be thinner than it appears.

Flat consumer spending points to lingering fragility in household demand. Falling business investment hints that companies are becoming more hesitant about expanding capacity in an uncertain global environment. And if external shocks worsen — whether through another bout of yen weakness, a fresh rise in oil prices or deeper shipping disruption tied to the Middle East conflict — the pressure could spread beyond exporters into the broader economy.

The timing is especially sensitive. Japan has spent years trying to establish a more durable cycle of wage growth, moderate inflation and stronger domestic demand after decades of stagnation and deflationary tendencies. A slowdown now could complicate that effort, especially if higher import costs continue to erode consumers’ purchasing power.

The Bank of Japan, meanwhile, faces a familiar but more delicate version of an old problem: moving too slowly risks another destabilizing drop in the yen, while moving too quickly could choke an economy that is still not showing strong, broad-based growth.

What Comes Next

The central question is whether the second-quarter weakness proves temporary or marks the start of a broader slowdown in the second half of the year.

Much will depend on forces largely outside Japan’s control. If tensions in the Middle East ease, oil and shipping costs could stabilize, giving manufacturers and households some breathing room. If the conflict worsens, Japan’s dependence on imported energy would again become a major vulnerability.

The yen is the other crucial variable. If it steadies, policymakers may avoid another immediate confrontation with markets. But if it resumes its slide, pressure will mount for further action — and with it, fresh debate over whether intervention without more decisive monetary tightening can do anything more than buy time.

For now, Japan’s latest growth figures offer a warning that the economy is entering that test with less strength than hoped.