Our economic outlook for Japan

We expect Japan’s economy to remain on a steady path toward normalization in 2026, despite lingering tariff-related uncertainty and political turbulence. (The ruling party’s secretary general said on January 14 that the prime minister plans to dissolve parliament and call a snap election, potentially as early as February.) Domestic demand remains resilient, with private consumption continuing to recover amid persistent inflationary pressures.

We forecast solid real GDP growth of 1% in 2026 and expect private consumption to remain firm, driven by strong wage growth and the positive impact of permanent income tax cuts. Capital spending should continue its upward momentum, supported by elevated corporate earnings. Exports are likely to post moderate growth, aided by a resilient U.S. economy and a weak yen, with the impact of U.S. tariff hikes proving limited thus far.

The Bank of Japan (BoJ) raised its policy rate by one-quarter of a percentage point to 0.75% at its December meeting, signaling growing confidence in sustained inflation and a commitment to continued policy normalization. We expect the BoJ to raise the rate to 1% by the end of 2026, with an eventual move toward 1.5%, our estimate of the neutral rate. (The neutral rate is the interest rate that would neither stimulate nor restrict economic activity.) We expect the pace of future hikes to be measured, contingent on wage negotiations, domestic demand trends, foreign exchange volatility, and global uncertainties.

On the fiscal side, larger-than-expected expansion under the new administration, combined with solid domestic demand and persistent inflationary momentum, is set to fuel underlying price pressures while raising concerns about fiscal sustainability over the medium term.