Japan's economy grew faster than initially estimated in the second quarter, reinforcing market expectations that the Bank of Japan will raise interest rates at its September 18 policy meeting.

Revised Cabinet Office data released Tuesday showed GDP expanded at an annualised 1.4%, up from the preliminary estimate of 1.1%, though it still fell short of economists' median forecast, which ranged from around 1.6% to 1.8% across surveys. On a quarterly, non-annualised basis, GDP grew 0.4%, matching the median forecast and improving on the preliminary 0.3% reading.

The revision itself was a modest beat against the preliminary figure but a miss against the median forecast — arguably the more useful signal: growth held up reasonably well through a quarter when Middle East disruption could plausibly have done more damage, and that resilience is exactly what the BOJ needs to justify hiking without appearing to risk the recovery.

Capex leads the revision

The upward revision was driven largely by capital expenditure, which fell 0.9% in the quarter — an improvement on the initial estimate of a 1.2% decline, though a slightly faster decline than the 0.8% forecast. The revision reflects capex data released last week showing Japanese firms lifted spending on plant and equipment by 1.6% year-on-year.

Private consumption, which accounts for more than half of the economy, was flat, unchanged from the preliminary reading. External demand added 0.5 percentage point to growth, also unchanged from the initial data, while the drag from domestic demand narrowed to 0.1 percentage point from 0.2% previously.

Economist reaction

Kento Minami, senior economist at Daiwa Securities (via a Reuters report), said the fact that growth held up around this level was notable given that the April-June quarter was a period when the Middle East situation could have exerted meaningful downward pressure on the economy. He added that the data leaves no reason to worry about growth and clears the way for the BOJ to proceed with a rate hike.

That view aligns with separate wage data also released Tuesday showing July real wages rose 2.4% year-on-year — the biggest increase since May 2021 and a seventh consecutive month of gains — adding further support to the case that Japan's wage-led recovery is durable enough to withstand tighter policy.

Market pricing

Markets have all but finalised their pricing on the outcome. Swap rates imply a 98% probability that the BOJ will raise its policy rate by 25 basis points to 1.25% at next week's meeting, with a further hike to 1.5% fully priced in by the January meeting, according to Tokyo Tanshi.

The BOJ lifted its policy rate to a 31-year high of 1% in June but has remained under pressure to tighten further amid price pressures stemming from the Middle East conflict and a weaker yen. That June move continued a tightening cycle that began when the central bank ended eight years of negative rates in March 2024 — a shift that marked Japan's exit from the ultra-loose policy framework it had maintained since the 2010s and turned policy meetings into regular event risk for global bond and currency markets. With swap markets already pricing a 98% chance of a move to 1.25% next week and a further hike to 1.5% fully priced by January, the GDP print is unlikely to shift near-term rate expectations much further, but it removes one of the last data-dependent objections to proceeding.

Yen and Nikkei implications

For the yen, the combination of a confirmed hike and a clear path beyond it is broadly supportive, particularly against a backdrop of yen weakness the BOJ has cited as a pressure point. The interest-rate gap with other major economies has been a persistent driver of that weakness, as Japanese rates — even after the hikes already delivered — remain below those in the US and Europe, keeping carry-trade pressure on the currency.

The read for the Nikkei is more mixed: the growth and wage story supports the domestic demand and earnings narrative, but further upward pressure on JGB yields as the hike path firms remains a headwind for rate-sensitive sectors, leaving exporters as the more likely relative outperformer through the decision.

With the hike itself now essentially a formality, investor attention is shifting to how the central bank frames the risks from the ongoing conflict and its past tightening as it assesses the path beyond September — a distinction likely to matter more for the yen and Nikkei than the decision itself. The next scheduled releases to watch include the BOJ's Outlook Report accompanying the meeting and monthly wage and inflation data, which will test whether the wage-led recovery narrative extends into the second half of the year.