Japan’s economy expanded at an annualized rate of 2.1% in the first quarter of 2026, topping analysts’ expectations on the back of stronger consumption and robust exports. The growth rate was higher than Reuters-polled analysts’ estimate of 1.7% and improved from 1.3% growth recorded in the previous quarter, as quoted on CNBC.
On a quarter-over-quarter basis, the economy grew 0.5%, above expectations of 0.4% and stronger than the 0.3% expansion seen in late 2025. On a yearly basis, GDP rose 0.6%.
Export Strength Drives Growth
Japan’s exports climbed 11.5% year over year in March, exceeding expectations. The increase was partly fueled by a 29.3% jump in semiconductor equipment shipments.
However, economists cautioned that the latest GDP figures do not fully reflect the economic impact of the Iran war, which began at the end of February.
BOJ Cuts Growth Outlook, Raises Inflation Forecast
The Bank of Japan lowered its fiscal 2026 growth forecast to 0.5% from 1% and sharply increased its core inflation projection to 2.8% from 1.9%.
At its May 7 meeting, the central bank warned that rising crude oil prices linked to the Middle East conflict would likely hurt corporate profits and household purchasing power, slowing economic growth this year.
Inflation in Japan accelerated in March for the first time in five months.
Japan May Roll Out Additional Fiscal Support
According to Reuters, Tokyo is considering issuing fresh debt to fund an extra budget aimed at cushioning the economic impact of the Middle East conflict, including subsidies for energy bills, as quoted on the same CNBC article.
Can the Nikkei Gain Ahead?
The rising trend of inflation may deter the central bank from going for policy easing in the near term. Moreover, the likelihood of more government spending and the suspension of sales tax on food has unnerved investors already concerned about Japan's debt burden, the largest in the developed world (as quoted on US News).
Uncertainty over funding risks could trigger a bond market sell-off and a rise in government bond yields. This, in turn, would increase the cost of servicing public debt that is roughly twice the size of Japan's economy (per Reuters). Deteriorating fiscal sustainability could also cause yen weakness and lead to higher import costs.
So, it all depends on how the prime minister deals with the entire scenario and to what extent a fiscal boost will be applied. It is also needed to be seen if any kind of yen intervention will be made. Till then, a short-term boost to equities should be seen.
Against this backdrop, investors can keep a close track of WisdomTree Japan Opportunities Fund OPPJ, First Trust Japan AlphaDEX Fund FJP, iShares JPX-Nikkei 400 ETF JPXN, Japan Smallcap iShares MSCI ETF SCJ and WisdomTree Japan SmallCap Dividend Fund DFJ.
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WisdomTree Japan SmallCap Dividend ETF (DFJ): ETF Research Reports
iShares JPX-Nikkei 400 ETF (JPXN): ETF Research Reports
iShares MSCI Japan Small-Cap ETF (SCJ): ETF Research Reports
First Trust Japan AlphaDEX ETF (FJP): ETF Research Reports
WisdomTree Japan Opportunities Fund (OPPJ): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).