OECD Economic Outlook, Volume 2026 Issue 1

Japan

Real GDP growth is projected to ease slightly to 0.6% in 2026 and 0.8% in 2027. Despite the headwinds from the rising cost of energy imports, domestic demand will be the main driver of growth. Robust wage growth and energy subsidies will support private consumption. Government consumption is set to remain high. Government subsidies and high corporate profits will boost investment in 2026, partly offsetting the energy shock. The increase in energy prices will be partly mitigated by government measures in 2026, and headline consumer price inflation is projected to move towards the 2% target in late 2027.

The fiscal stance is projected to be expansionary in 2026, following 2025 tax reforms and additional energy subsidies. In the absence of supplementary budgets, fiscal policy will tighten in 2027. Given rising interest rates, elaborating a clear and credible medium-term fiscal consolidation plan, underpinned by specific expenditure and tax measures, is needed to secure medium-term fiscal sustainability. While increased uncertainty due to the evolving conflict in the Middle East creates challenges, the gradual withdrawal of monetary accommodation should be continued, given robust wage growth and projected inflation around the 2% target. Enhancing energy security requires stepping up the promotion of research, development and deployment of green technologies and increasing renewable energy production.

The evolving conflict in the Middle East is partly disrupting the robust growth in early 2026

Real GDP grew robustly at 0.5% (quarter-on-quarter) in the first quarter of 2026. Private consumption and investment remained resilient, reflecting robust corporate profits and momentum in nominal wage growth. The Bank of Japan (BoJ)’s March Tankan Survey points to the tightest labour market in three and a half decades, which will further support wage increases and investment in labour-saving technologies. The preliminary outcomes for the 2026 Shunto wage negotiations imply an increase of 3.5% for base pay and 5.1% for total wages. Firms’ profits and investment plans in FY2026 remain solid according to the March Tankan Survey but could be underestimating the impact of the conflict. Headline consumer price inflation was 1.4% in April, due to easing food prices, and temporary energy subsidies.

The effective tariff rate of the US to Japan edged down slightly as across-the-board tariff rate was reduced to 10% from 15% in February. Goods and service exports grew by 1.7% in the first quarter of 2026, partly due to the recovery of automobile exports and strong demand for electrical machinery, including that for semiconductors. Nevertheless, risks from the evolving conflict in the Middle East have increased. Japan imports around 90% of its crude oil from the Middle East. Although Japan maintains abundant strategic reserves (equivalent to around seven months of consumption) as of 23 May 2026 and only imports around 10% of its LNG from the Middle East, elevated oil and gas prices could erode corporate profits and damp demand. Import prices rose by 17.5% over the year to April.

Japan 1

1. 2026 values are as of 7 May.

2. Non-financial firms. Horizontal axis indicates fiscal years. For FY2025 and FY2026, firms’ plans on current profits and investment were extrapolated.

Source: Japanese Trade Union Confederation; Bank of Japan; and OECD calculations.

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Japan: Demand, output and prices

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Japan 2

Source: Bank of Japan; and OECD Economic Outlook 119 database.

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Monetary policy is projected to tighten, while fiscal policy will support growth in 2026

The Bank of Japan has taken steps toward monetary policy normalisation by starting to reduce the size of its balance sheet and raising the policy interest rate, which reached around 0.75% in December 2025. Despite volatility in headline consumer inflation due to temporary factors and the energy shock in the first half of 2026, inflation is projected to converge towards target at the end of 2027. Firms currently expect inflation above target, at 2.5% for three-to-five years horizons, according to the March Tankan Survey. The breakeven inflation rate on 10-year JGBs has been trending up and was 1.89% at the end of April. While uncertainty from external headwinds warrants a cautious approach, the policy rate is projected to increase gradually to 2% by the end of 2027, given higher inflation expectations, solid nominal wage growth and the closing of the output gap.

The overall fiscal stance between 2025 and 2027 is contractionary, assuming no additional supplementary budgets in FY2026-27. The primary deficit is projected to increase from 1.0% of GDP in 2025 to 1.6% of GDP in 2026, reflecting the November 2025 stimulus package, income tax reforms and fuel subsidies. The primary balance is set to improve but remain negative in 2027. OECD projections assume additional spending on high school tuition assistance (0.1% of GDP) and defence (0.2% of GDP) in FY2026. The higher income deduction in the personal income tax from FY2025 is expected to reduce tax revenues by 0.2% of GDP. A special corporate tax surcharge of 4% for tax liabilities exceeding JPY 5 million was introduced in April 2026 to partly finance the increase in the defence budget. The cap on retail gasoline prices and additional subsidies on electricity and gas (between July and September) introduced in response to rising prices are assumed to cost 0.3% of GDP. Backloading of retirement benefits of public servants due to the extension of the retirement age will also raise government consumption in 2026. Despite these spending pressures, the gross public debt-to-GDP ratio is projected to decrease from around 205% in 2024 to around 189% in 2027, as nominal growth surpasses debt servicing costs.

The economy is set to grow moderately despite external headwinds

Real GDP is projected to ease slightly but continue to expand at a moderate pace, growing above potential at 0.6% and 0.8% in 2026 and 2027, respectively. With the headwinds from the rising cost of energy imports, domestic demand will ease but remain the main driver of growth. High corporate profits will enable continued solid wage growth, which will support private consumption. Business investment is projected to be supported by ample internal finance and government measures, including the fiscal stimulus package introduced in November 2025. Stronger price pressures due to higher energy prices are partly offset by subsidies, and headline consumer price inflation is projected to move back to the 2% target in late 2027.

The main risks are higher energy prices, potential disruptions in supply chains and weaker-than-expected external demand due to geopolitical tensions and trade policy uncertainty. A prolonged disruption to shipments through the Strait of Hormuz could adversely affect households and firms. Sharp movements in bond and equity prices could destabilise financial markets and hurt the balance sheets of financial institutions and the government. A loss of confidence in Japan’s fiscal sustainability and an increase in the sovereign risk premium could also adversely affect the financial sector and the real economy. Faster-than-expected reconstruction of global supply chains and the development of new export channels could further boost exports and support growth.

Building fiscal buffers against shocks and boosting productivity are priorities

Policies need to balance keeping inflation around the 2% target, ensuring fiscal sustainability and boosting potential growth. In a context of increasing debt servicing costs, putting public debt on a downward trajectory should be prioritised. The government should limit the use of supplementary budgets to large economic shocks and elaborate a clear and credible medium-term fiscal plan to achieve primary surpluses early on and then maintain them. Untargeted measures to cushion the impact of higher energy prices, such as the recent price cap on fuels, can be fiscally costly and distort price signals. Any further policies, if needed, should be targeted and temporary. Improving the relevance and targeting of adult learning to increase participation by female, older and non-regular workers and boosting the flexibility of labour markets would help counter adverse demographics and tackle labour shortages. Raising productivity requires strengthening competition and making public support to small and medium-sized enterprises more effective to increase business dynamism, encouraging foreign direct investment to unlock productivity spillovers and reforming the innovation framework and incentives for start-ups. Streamlined permitting processes are needed to increase the share of renewables in electricity production, boosting energy security.