Japan’s Nominal GDP Hits Record High for Fifth Straight Year. Q1 Economy Beats Expectations. Is a June BOJ Rate Hike a Done Deal?

TradingKey - Data released by the Japanese government on Tuesday showed that nominal GDP for fiscal year 2025 grew 4.2% year-on-year, marking the fifth consecutive year of positive growth as total nominal GDP continued to hit record highs. The annualized GDP growth rate for the first quarter of 2026 reached 2.1%, exceeding the 1.7% median forecast of analysts surveyed by Reuters and significantly higher than the 1.3% growth in the previous quarter.

In response, Takayuki Toji, senior economist at Japan Post Insurance, stated that the government may be more willing to accept further interest rate hikes, potentially leaving room for the Bank of Japan to raise rates as early as June or July, before the release of the next set of GDP data.

Rising Energy Prices Dampen Economic Growth Expectations

Since the conflict between the U.S. and Iran did not break out until late February, while the GDP data for this quarter spans from January to March 2026, the transmission effects of the Middle East war on the economy will be more fully reflected in subsequent quarters.

Norihiro Yamaguchi, Chief Japan Economist at Oxford Economics, noted that while the first-quarter performance was healthy, high energy costs will become a heavy burden moving forward. The Bank of Japan's growth projections have also accounted for the energy impact, lowering the fiscal 2026 growth forecast from 1% to 0.5%. Additionally, as energy costs intensified inflationary pressures, the central bank significantly raised its core inflation forecast to 2.8%, up from the 1.9% projected in January. In March, Japan's core CPI rose 1.8% year-on-year, the first acceleration in growth in five months. This figure was recorded despite the government's aggressive fuel subsidies and other measures, highlighting the significant impact of the Middle East war on inflation.

June Rate Hike Probability Surges to 77% as BoJ Officials Turn Hawkish

Currently, swap market data indicates that the probability of a Bank of Japan (BoJ) rate hike in June has surged to 77%. In a survey of 62 economists conducted from May 7 to 14, 65% of respondents expect the BoJ to raise interest rates by 25 basis points in June, lifting the benchmark rate to 1%, which is largely consistent with the April survey results; only one person expects that the BoJ will not raise rates before the end of September.

Judging from the statements of Bank of Japan officials, a June rate hike also appears highly likely. The BoJ kept interest rates unchanged at 0.75% last month, but three of the nine members of the Monetary Policy Committee dissented, advocating for a hike to 1%, reflecting growing vigilance toward inflationary pressures from energy price hikes triggered by the war.

Among the six officials who voted to keep rates unchanged, some have already shifted to a hawkish stance. Board member Kazuyuki Masu stated last Thursday that while he judged in April that there was no need to rush a rate hike, he now believes that if the data shows no clear signals of an economic downturn, rates should be raised as early as possible.

Minutes from the Bank of Japan's April meeting show that some officials believe: "Even if the future direction of the Middle East situation remains uncertain, it is highly likely the BoJ will start raising rates from the next meeting." Currently, the BoJ's policy rate remains far below the neutral rate level, so the central bank needs to raise rates steadily every few months; if inflation risks trend further upward, it should be even more decisive in accelerating the pace of hikes. Many officials stated that as the conflict in the Middle East intensifies inflationary pressures, it increases the risk of second-round effects—the potential for translation into long-term, widespread inflation—and advances the timeline for core inflation to reach 2%.

However, the BoJ's pace may face opposition from the government. A Japanese government advisory panel previously warned that the BoJ should remain prudent in formulating monetary policy given the deterioration in the corporate financing environment and the uncertainty brought by the situation in the Middle East, which was interpreted as a direct reminder to Governor Kazuo Ueda.

Analysts have outlined three possible paths for the BoJ's future monetary policy: it may keep rates unchanged in June while signaling a clear hawkish shift, waiting for July inflation and wage data for confirmation before hiking; if subsequent CPI continues to exceed expectations and depreciation pressure on the Yen intensifies, it may choose an early hike in June, bringing the benchmark rate to 1.0% by year-end; however, if a sudden escalation in the Middle East leads to further surges in energy prices or a sharp slowdown in global growth, the BoJ might choose to wait until the fourth quarter to guard against vicious cost-push inflation eroding the economy and the contraction of external demand hitting Japanese exports.