Japan's economy lost momentum in the January-March quarter from the previous three months on sluggish capital expenditure, revised gross domestic product data showed on Monday, pointing to challenges ahead due to the Middle East conflict.
However, economists said the broader economy would likely remain resilient in coming months with the fallout from the Iran war not expected to seriously hurt private consumption or corporate investment.
The Bank of Japan is still expected to maintain its plan to continue raising interest rates.
"There will almost certainly be continued downward pressure. But from the BOJ's standpoint, the bigger concern is the risk of prices overshooting," said Kento Minami, senior economist at Daiwa Securities.
"My view is that the January-March GDP data show Japan's economy was still resilient before tensions in the Middle East escalated. Given incoming data for the April-June quarter, as well as government actions and economic policy, the economy is likely to remain firm. That suggests the BOJ may have to tilt more toward rate hikes."
Temporary dip?
The GDP figures released by the Cabinet Office showed the economy expanded an annualised 1.8% in the first quarter, worse than the initially estimated 2.1% but better than economists' median forecast for 1.3% growth.
Without annualisation, GDP grew 0.5%, slightly above the median forecast for a 0.3% expansion and matching the preliminary figure.
Businesses' capital expenditure shrank 0.7% in the first quarter, revised down from the initial estimate for a 0.3% rise and compared with an estimated 0.9% drop.
The downward revision reflected corporate spending on plant and equipment data that was released after the preliminary GDP figures.
A Cabinet Office official said sectors posting steep quarter-on-quarter declines included custom software, computers and office machinery.
Daiwa's Minami said the uptrend in spending on labour-saving measures and AI has not changed, adding the contraction looks more like a temporary dip than a change in trend.
Private consumption, which accounts for more than half of Japan's economy, increased 0.3%, also matching the initial data.
External demand, or exports minus imports, added 0.3 percentage point to GDP, unchanged from the preliminary data. Domestic demand contributed 0.2 of a percentage point, also matching the initial figure.
Heavy war uncertainty
Japanese Prime Minister Sanae Takaichi's government on Wednesday finalised a $19 billion supplementary budget for this fiscal year to cushion the impact of rising energy costs on households from the Middle East crisis.
U.S.-Israeli strikes on Iran in late February and Tehran's effective closure of the Strait of Hormuz, which normally carries a fifth of global oil and gas, have sent prices soaring and raised fears of a major disruption to energy flows.
Japan's heavy reliance on Middle Eastern oil leaves it acutely exposed. Rising fuel costs are stoking inflation, eroding household purchasing power and tightening corporate margins, heightening the risk of a severe economic downturn if disruptions persist.
While the economy is still likely to grow overall, it could stagnate or contract in the third quarter if Middle East tensions persist and the Strait of Hormuz remains closed, said Shinichiro Kobayashi, principal economist at Mitsubishi UFJ Research and Consulting.
The Bank of Japan will hold a two-day policy meeting next week. Sources told Reuters the bank is expected to raise interest rates this month unless a sharp escalation in the conflict roils markets.
"If the situation in the Middle East begins to stabilise, the negative impact on the economic outlook will gradually fade," Kobayashi said. "But if price increases continue to some extent, and if the Fed actually goes ahead with further rate hikes, the yen would likely weaken, creating conditions in which the BOJ could find it easier, or necessary, to raise rates again."
(Reporting by Satoshi Sugiyama; Additional reporting by Makiko Yamazaki; Editing by Sam Holmes)
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