Japanese Economy: Moderate Recovery Continues

■ The weak real GDP growth in the October-December quarter was mainly dragged down by inventory reductions, while domestic demand continued its steady recovery.  

■ The seemingly weak growth rate may prompt increased fiscal spending, and attention should be paid to the size of the autumn supplementary budget. 
 
The preliminary value of Japan's real GDP (Gross Domestic Product) for the October-December quarter, released on the 16th, showed an annualized growth rate of 0.2%, only a slight positive growth after a 2.6% decline in the July-September quarter. On the same day, the foreign exchange market saw a trend of buying the US dollar and selling the yen due to the lower-than-expected growth data, leading to the market's belief that the Bank of Japan would be unlikely to raise interest rates soon. However, structurally, the data was not as weak as the surface figures suggested, still indicating a moderate recovery in domestic demand. Specifically, personal consumption (up 0.4% quarter-on-quarter) and equipment investment (up 1.0% quarter-on-quarter) showed a continued growth trend; in addition, influenced by the rebound in demand due to legal amendments, residential investment (up 20.4% quarter-on-quarter), which had fallen sharply in July-September, also rebounded strongly. In terms of their contribution to economic growth, equipment investment, personal consumption, and residential investment combined contributed 1.1 percentage points to GDP growth at an annualized rate, indicating that domestic economic activity remained robust at the end of the year. However, changes in private inventory dragged down growth by 0.8 percentage points, essentially offsetting the positive contribution of domestic demand. 

 
The negative contribution of private inventory suggests that companies may have accelerated inventory reduction at the end of last year as orders increased. The final industrial production index released on the 16th showed that the manufacturing inventory index, after falling to its lowest level since mid-2021 in November, only rebounded slightly in December. The decline in inventory is expected to prompt companies to expand production to replenish inventory in early 2026. The manufacturing production forecast survey released on January 30th showed that the manufacturing production forecast index (up 9.3% month-on-month in January) and the revised value from the Ministry of Economy, Trade and Industry (up 7.2% month-on-month) both rose sharply in January, with industries such as transportation machinery, general and production machinery, and electronic components and devices expected to drive increased production. Against the backdrop of continued moderate growth in personal consumption and equipment investment, real GDP growth in the first quarter of 2026 is expected to be boosted by inventory replenishment. 
 
However, weak apparent growth may still prompt the government to expand fiscal spending. According to the fiscal schedule, a special session of the Diet is scheduled to convene on the 18th, and Takaichi is expected to be nominated as Prime Minister. Following this, there will be a policy address, questioning by party representatives, and deliberation on the initial budget for fiscal year 2026. The budget is expected to pass the House of Representatives around the end of March, then the Senate, and, leveraging the House's superiority, is expected to be formally enacted around the end of April. The initial budget for fiscal year 2026 achieved a slight primary balance surplus, maintaining fiscal discipline to some extent. Going forward, with the Takaichi government pursuing its growth strategy and the National Assembly expected to be established before summer to discuss consumption tax cuts, the size of the supplementary budget in the fall will be a focus of market attention.