GDP growth forecasts for Japan have been revised downward, now predicting an increase of only 0.8% in 2025 and a mere 0.2% in 2026. This adjustment accounts for the effects of heightened US tariffs and persistent global trade policy uncertainties. As a result, Japan’s economy is expected to experience minimal growth during the 2025-2026 period.
- We’ve cut our GDP growth forecasts for Japan by 0.2ppts to 0.8% in 2025 and by 0.4ppts to 0.2% in 2026, reflecting higher US tariffs and heightened global trade policy uncertainty. We now forecast that Japan’s economy will barely grow over 2025-2026 on a sequential basis.
- We assume that the effective US tariff rate on Japanese goods will stay at 16%, up from 2% at the end of 2024. The US has postponed its 24% ‘reciprocal’ tariff for 90 days, but a universal 10% tariff and higher tariffs for autos and steel will continue to be applied. We don’t think Japan’s government will impose retaliatory tariffs, hoping to reach a deal with the US within 90 days.
- Weaker growth will likely result in lower inflation once the ongoing supply-driven food inflation abates. We now think the CPI will rise by 1.6% in 2026, down from our prior 1.8% projection. While lowered import prices suggest input cost pressures will be tame, weaker domestic growth will limit firms’ pricing power.
- We now think the Bank of Japan won’t rush to hike the policy rate. We expect the BoJ will maintain the current policy rate this year and next, and only raise rates in 2027. The political cost of continuing to hike rates is high when a sense of crisis is widely shared across the nation.
- Reflecting the lower policy rate outlook, we have lowered our long-term yield forecast. We now expect the 10-year JGB yield to stay at around 1.55%, instead of the previous 1.7%, despite higher term premia assumptions.
The US has postponed its shock 24% ‘reciprocal’ tariff on Japan for 90 days to allow negotiations. However, a universal 10% tariff and separate higher tariffs for autos (passenger cars: 27.5%, trucks: 50%) and steel (25%, quota exemptions removed) will still be applied on Japanese exports to the US.
We now project that Japan’s GDP will barely grow in 2025-2026, whereas we had expected a modest recovery in our March forecast (Chart 1). Reflecting the larger hike in the effective US tariff rate due to the auto sector’s large share in Japan’s exports to the US, our growth downgrade for Japan in 2025 is slightly larger than that for the Eurozone and the UK.
We have cut outlooks for both exports and investment. For exports, shipping to the US will be hit directly by lower demands due to higher tariffs. We calculate that Japan will be subject to an effective US tariff of 16%, which is higher than that on most other developed economies
The impact will be particularly evident in the auto sector, which relies heavily on the US market and is subject to tariffs higher than the universal 10%
Retaliatory tariffs are still unlikely
We continue to assume the Japanese government will not impose retaliatory tariffs to avoid provoking the US ahead of trade talks. The government is seeking to reach a deal with the US within the 90-day window. Trade talks between the US and Japan have just kicked off on 17 April, with Japan’s economy minister Ryosei Akazawa meeting Scott Bessent and Jamieson Greer in Washington DC. Future discussions will likely include FX rates, joint participation in Alaskan LNG projects, and increasing purchases of US defence goods, and tariff-free rice imports.
Instead of retaliatory tariffs, the government is using fiscal measures to mitigate the negative effects on the economy. The requirements for safety-net loans to SMEs affected by high US tariffs were eased and the coverage of government-backed trade insurance was widened to include losses due to tariff measures. In addition, the government is reportedly considering an additional economic package, including an extension of gasoline subsidies.
We expect some sort of trade deal will be reached and the 24% reciprocal tariff will be avoided. If negotiations should break down and 24% reciprocal tariff are enforced, however, our modelling suggests that Japan’s GDP will dip by an additional 0.1% by end-2026.
Tariffs are likely to prove disinflationary for Japan
We think the tariff turmoil will have a deflationary impact on Japan. We have lowered our 2025 CPI forecast by 0.1ppts to 2.7% y/y, and 2026 CPI by 0.2ppts to 1.6%. Ongoing supply side-driven food inflation is likely to persist in the coming quarters, but the tariff turmoil is likely to lower inflation after then.
On the demand side, weaker growth will limit firms’ pricing power. Lower commodity prices also mean tamer cost pressures. A stronger yen on the flip side of a weakened US dollar will also reduce import costs. We currently assume the yen will stay weak at around JPY150/USD in 2025 once the market turmoil subsides, before appreciating gradually later with a tighter US-Japanese yield gap.
At the same time, we see an upside risk to inflation. Global supply chain disruptions could result in higher inflation. In this case, the economy would be hit even harder by worsened terms of trade. Our modelling suggests that Japan’s economy would fall into a deep recession in 2025-2026, with the CPI rising toward 4% by early 2026, assuming global supply chain stresses rise to pandemic high.
The BoJ to take a long pause
We now expect the BoJ to maintain the current policy rate this year and in 2026, then hike to 0.75% in Q3 2027 after carefully assessing the growth, wage, and inflation developments.
We believe the BoJ is likely to become far more cautious regarding policy rate hikes due to the weaker growth prospects and high trade policy uncertainty. Although a secular labour shortage will sustain the large firm-led wage growth trend in the coming years, the damage from tariffs could make it more difficult for small firms to keep raising wages. Also, the political cost of continuing rate hikes is high, as the government, business community, and public share a sense of crisis. The weak growth and inflation prospects might open the door for a rate cut, but the US criticism of a yen-weakening policy and the BoJ’s still-strong appetite for monetary policy normalization will likely support a wait-and-see approach.
Indeed, on April 16, BoJ governor Ueda said that US trade policy has “moved closer towards the bad scenario,” and the bank may need to take action if tariffs hurt the economy.
On the long-term yield, we have lowered our 10-year yield outlook by 15bps to 1.55% (Chart 6). Although we continue to think the term premium will increase with rising uncertainty both domestically and globally, lower policy rate outlooks have prompted us to downgrade long-term yields. In the near-term, we think the JGB yield will stay at around the current level in the coming quarters, before gradually rising again from 2026 as the negative shock to the economy from tariffs starts to ease.
Source: Oxford Economics/Haver Analytics
