Japan's economy shrank an annualized real 2.0 percent in the January-March period, marking the first contraction in two quarters, as domestic demand took a beating from higher inflation and a halt in vehicle shipments caused by a safety testing scandal at Daihatsu Motor Co., government data showed Thursday.

Real gross domestic product in the first quarter of 2024, adjusted for inflation, declined 0.5 percent from the previous quarter. GDP is the total value of goods and services produced in a country.


The contraction was widely expected as economists polled by the Japan Center for Economic Research had forecast a contraction of an annualized real 1.17 percent, or 0.29 percent from the previous quarter.

Analysts say the economy will stage a rebound in the April-June quarter. But the data also points to the difficulty that the Bank of Japan faces in pursuing another rate hike as it grapples with the prospect of slow growth, inflation and a weak yen.

Private consumption, which accounts for more than half of the economy, fell 0.7 percent, down for the fourth straight quarter, according to the Cabinet Office.

The longest losing streak in 15 years underscored slackening domestic demand, a critical factor for Japan to strengthen a positive cycle of pay and price hikes that would enable the BOJ to reduce the monetary stimulus it has maintained amid its fight against chronic deflation.

"When real wage growth remains negative, it's hard to expect strong private consumption...Japan's GDP growth would have been around zero at best even without the latest auto scandal," said Saisuke Sakai, a senior economist at Mizuho Research & Technologies Ltd.

The institute estimates that Japanese households will pay an additional 106,000 yen ($690) or more in the current business year to March due to inflation caused by rising crude oil prices, a weak yen and other factors.

Financial markets expect the central bank to raise interest rates again later this year as pressure could mount on the BOJ to counter the yen's weakness, a byproduct of its dovish stance.

Capital spending dropped 0.8 percent, falling for the first time in two quarters. Japanese companies curbed investment in machinery and auto-related items, after a data-rigging scandal at Daihatsu, a Toyota Motor Corp. group firm.

The auto industry is a key driver of the Japanese economy, with the latest GDP data highlighting the ripple effects of the scandal that affected spending by consumers and firms as well as exports.

Exports declined 5.0 percent despite a continued boost from inbound tourism. Imports fell 3.4 percent amid a drop in energy imports.

Japan has benefited from a recovery in inbound tourism, fueled in part by the yen's depreciation that makes travel to and spending in Japan cheaper for foreign tourists. Their spending is counted as exports in the GDP data.

The weakening of domestic demand coincides with inflation outpacing wage growth. This comes despite the annual wage negotiations in the spring between labor unions and management yielding the best outcome in three decades, after major companies weighed the impact of the recent bout of cost-push inflation and agreed to hike pay.

"For continued wage growth, corporate profits are important. Small and midsize firms have had to offer higher pay to ease their labor shortages but the weaker yen is becoming a headwind. The same is true for service providers," Sakai said, adding the BOJ will likely wait until September or October to go ahead with another rate hike.

Inflated by rising prices and the yen's depreciation, nominal GDP increased 0.1 percent from the previous quarter, or 0.4 percent on an annualized basis.

Japan narrowly missed its target of boosting the size of its economy to 600 trillion yen or more, as it totaled 599 trillion yen, according to the data.

Toru Suehiro, chief economist at Daiwa Securities Co., said the weak GDP data sheds light on the negative side of the yen's decline.

"We can't rule out the possibility that the BOJ will come under pressure to tighten policy further to do something about the weak yen," Suehiro said. "My view is that the BOJ would rather choose to persist with monetary easing."

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