Japan: GDP Growth in Q2 2025 Exceeded Expectations — Implications for Markets
Key Figures
- GDP q/q: +0.3% (forecast +0.1%; previous value +0.1%).
- GDP y/y: +1.0% (forecast +0.4%; previous value +0.6%).
The preliminary GDP estimate for Japan indicates an acceleration in growth relative to expectations, which heightens investor interest in assets sensitive to domestic demand and investments.
Drivers of Japan's Economic Growth
- Domestic Demand: Stable household consumption supports services and retail.
- Business Investments: Modernization of production capacities and digitalization improve productivity.
- Exports: Steady external demand for high-tech products and automobiles enhances the contribution of net exports.
The combination of internal and external factors makes the current growth trajectory more balanced, reducing dependence on a single source of dynamics.
Inflation and the Bank of Japan's Policy
- Interest Rate Policy: Strong GDP data increases the likelihood of more decisive steps towards policy normalization.
- Price Transmission: Accelerating activity could support core inflation through wages and services.
- JGB Yields: The market may price in a gradual increase in yields, reflecting a reassessment of the interest rate trajectory.
For the Bank of Japan, the key will be balancing support for economic growth and controlling inflation expectations.
The Yen and the Currency Market
- Surprise Factor: GDP forecasts exceeding expectations traditionally strengthen the yen through a reassessment of rate expectations.
- Yield Differential: Convergence with global rates may narrow the yen's discount against major currencies.
- Risks: A stronger yen may temporarily pressure export-oriented companies.
For yen crosses, an increase in volatility is likely as signals from the regulator and published inflation indicators emerge.
Japanese Equity Market: Potential Beneficiaries
- Domestic cyclicals: Banks, developers, and consumer services benefit from the revival of demand.
- Capital Goods: Industries and segments focused on capital expenditures gain support from increased CapEx.
- Technology and Automotive: Maintain reliance on exports but are sensitive to the yen's exchange rate.
Sector selection suggests a balance between "domestic stories" and export-oriented leaders, taking currency hedging into account.
Bond Market and Cost of Capital
- JGB Yields: A gradual uplift on long-term issues may occur with a reassessment of rate expectations.
- Credit Market: Corporate spreads remain resilient amid an improving macro environment.
- Cost of Funding: Gradual interest rate increases may moderately raise the cost of capital for businesses.
For fixed income investors, duration and selection of issuers with stable cash flow are critical.
Scenarios for the Second Half of 2025
- Base Case: GDP growth near 1% y/y; gradual normalization of the Bank of Japan's policy; moderate strengthening of the yen.
- Positive Case: Acceleration of consumption and investments; a stronger yen; leading growth in domestic demand sectors.
- Constrained Case: Slowing external demand and strengthening yen pressure exports; growth below trend.
Key Risks
- External Environment: Weakening global demand and prices for Japan's export goods.
- Currency: Excessive strengthening of the yen undermines export competitiveness.
- Inflation Expectations: Accelerating wages may support higher core inflation.
What Investors Should Monitor
- Inflation releases (CPI, core CPI) and wage dynamics.
- The Bank of Japan's rhetoric and changes in asset purchase programs.
- Industrial orders, retail sales, and export/import as high-frequency indicators.
- The yen's exchange rate and JGB yields across key maturities.
Portfolio Takeaway
The stronger-than-expected growth of Japan's GDP in Q2 2025 strengthens the case for selectively increasing the allocation to Japanese assets. In equities — focus on domestic cyclicals and companies with stable margins; in bonds — cautious duration and quality issuers. For currency positioning, a partial hedge is advisable given the risk of further strengthening of the yen amidst potential normalization of Bank of Japan's policy.
