Japan's government confirmed in a revised report that the economy contracted in the three months through September, providing justification for the stimulus package announced last month by Prime Minister Sanae Takaichi. The revised data showed Japan's GDP shrank at an annualized rate of 2.3% in Q3, as both business spending and housing investment were weaker than preliminary figures indicated. This contraction—larger than the initially reported 1.8% decline—marks the first economic downturn in six quarters.

The lackluster results support Takaichi's stimulus plan, which represents the largest new spending package since the pandemic. With the economy contracting at the start of her term and private consumption remaining sluggish, these figures may justify further fiscal expansion. However, the data adds complexity to the Bank of Japan's upcoming policy decision, though it is unlikely to derail its gradual rate-hike trajectory.

"Prime Minister Takaichi could leverage the recent slowdown to justify large-scale stimulus," said Uichiro Nozaki, an economist at Nomura Securities. However, he noted that with Japan's output gap nearly closed, sustaining economic arguments for additional spending will be challenging. "I still expect the economy to return to positive growth next quarter following this temporary dip."

To ease inflation's burden on households, Takaichi unveiled a ¥17.7 trillion ($114 billion) stimulus package, including utility subsidies, tax cuts, and wage support measures for small businesses. The government estimates the plan could boost GDP by an average of 1.4 percentage points annually over three years.

Mitigating inflation's impact is critical for Takaichi, as her predecessors faced public backlash over rising living costs. Economist Taro Kimura noted, "The deeper Q3 contraction strengthens the case for fiscal stimulus but won't stop the BOJ from hiking rates in December. The central bank will likely view the GDP weakness as temporary."

Overnight index swaps now price in a 90% chance of a BOJ rate hike this month after Governor Kazuo Ueda strongly hinted at tightening. Officials are prepared to raise rates barring major economic or financial shocks.

The revised GDP incorporated additional data, including capital expenditure figures, which showed businesses cut investment for the first time in six quarters—partly due to uncertainty over U.S. tariffs. Net exports remained weak, while private consumption provided only a marginal 0.2% boost.

Inflation continues to outpace wage growth, with real wages falling 0.7% in October—the 10th straight decline. Core inflation has stayed at or above the BOJ's 2% target for over three and a half years, the longest stretch since the early 1990s.

Risks loom ahead, including a weaker yen (hovering near ¥155/$) and potential drags from U.S. trade policies. Still, economists expect a slow recovery, with consumption gradually improving alongside earnings. "While major growth drivers are absent, the recovery should persist," said Keiji Kanda of Daiwa Institute.