Japan's Economy Dodges Recession with Modest Growth Amid Lagging Exports
By John Nada·Feb 16, 2026·5 min read
Japan's economy saw a slight 0.1% growth in Q4 2025, narrowly avoiding recession but missing forecasts, signaling ongoing challenges in recovery efforts.
Japan's economy grew 0.1% in the fourth quarter of 2025 compared with the previous three months, narrowly avoiding a technical recession. This growth marks a reversal from the 0.7% contraction seen in the third quarter, yet it fell short of economists' expectations, who had forecasted a 0.4% expansion. A technical recession is commonly defined as two consecutive quarters of contraction, and while Japan managed to avert this fate, the modest growth highlights the ongoing challenges it faces in the broader context of economic recovery.
On an annualized basis, Japan's output rose by 0.2%, a stark contrast to the forecasted 1.6% and following a notable decline of 2.3% in the previous quarter. Year-over-year comparisons for the fourth quarter also reveal a slowdown, with GDP expanding just 0.1%, down from 0.6% in the third quarter. This modest growth was primarily driven by private consumption, which played a vital role in countering weaknesses in both exports and public spending, according to data from Japan's Cabinet Office.
Following the release of these economic data, the Nikkei 225 index opened slightly higher, up 0.12%. However, the yen weakened by 0.25% against the dollar, reflecting investor sentiment regarding Japan's economic outlook. The Bank of Japan had recently raised its economic growth forecast for the fiscal year ending March 2026 from 0.7% to 0.9%. This adjustment indicates expectations for a gradual recovery, bolstered by accommodative financial conditions and a virtuous cycle of rising prices and wages.
The current economic landscape in Japan is further complicated by its collaboration with the United States, particularly in light of the ongoing $550 billion investment pledge under a trade deal with Washington. Reports suggest that Tokyo and Washington are still in discussions, with no initial projects agreed upon as of yet. Economy Minister Ryosei Akazawa expressed hopes for these projects to be finalized before a significant meeting between Prime Minister Sanae Takaichi and U.S. President Donald Trump. Takaichi's recent electoral victory positions her to play a crucial role in shaping Japan's economic strategy, as she advocates for proactive fiscal policies, including a record budget aimed at boosting economic growth and addressing cost-of-living pressures.
In the lead-up to the elections, Takaichi had announced a record 122 trillion yen budget for the fiscal year starting April 1, marking the second consecutive year of record spending. This budget is particularly significant as it includes measures to support households grappling with rising living costs, amidst concerns that inflation could undermine consumer spending. Japan's inflation rate had recently slowed to 2.1% in January, marking its lowest level since March 2022. However, it is important to note that prices have remained above the Bank of Japan's 2% target for an extended period, specifically for 45 consecutive months.
The Bank of Japan's dual mandate of supporting growth while maintaining price stability is under increasing scrutiny, especially as inflationary pressures persist. The recent adjustments in the growth forecast suggest a cautious optimism within the central bank, highlighting expectations for moderate expansion as other countries begin to return to growth. This perspective aligns with broader global economic trends, where many economies are experiencing a resurgence as they recover from the impacts of the pandemic.
Moreover, experts are anticipating that defense spending will serve as a key catalyst for Japanese equities. Bruce Kirk, Chief Japan Equity Strategist and managing director at Goldman Sachs, has indicated that the upcoming meeting between Takaichi and Trump could lead to a "flurry of announcements" involving collaboration between Japanese and U.S. companies in sectors such as industrialization, factory automation, and shipbuilding. These industries are crucial for revitalizing Japan's manufacturing sector, especially amidst ongoing global economic pressures.
The implications of Japan's economic performance extend beyond its borders, particularly as it seeks to strengthen ties with the U.S. This collaboration comes at a critical time when geopolitical tensions and trade dynamics are shifting. Takaichi's policies, coupled with the outcomes of the investment pledge with Washington, will be pivotal for Japan's long-term economic trajectory.
As Japan navigates these complexities, the government is also focused on addressing domestic challenges, such as rising energy costs and supply chain disruptions that have arisen from the global pandemic. The commitment to proactive fiscal measures, including increased defense spending to 2% of GDP, indicates a strategic shift aimed at not only bolstering economic growth but also enhancing national security.
In this context, the Japanese government’s approach to fiscal policy and its partnership with the U.S. will be closely monitored by investors and analysts alike. The potential for increased defense collaboration and industrial synergies could provide a much-needed boost to Japan’s economy, especially in sectors that have faced significant challenges in recent years.
The recent economic data and forecasts underscore the delicate balance Japan must maintain as it seeks to foster growth while managing inflationary pressures and public sentiment. The upcoming months will be critical as the government works to implement its fiscal strategies amidst a complex global environment, characterized by ongoing economic uncertainty and shifting geopolitical landscapes.