Japan’s economy contracts in first quarter

Japan’s economy contracted in the first quarter, squeezed by weaker consumption and external demand and throwing a fresh challenge to policymakers as the central bank looks to lift interest rates away from near-zero levels.

Preliminary gross domestic product (GDP) data from the Cabinet Office on Thursday showed Japan’s economy shrank 2.0% annualized in the January to March months from the prior quarter, faster than the 1.5% drop seen in a Reuters poll of economists. Downwardly revised data showed GDP barely grew in the fourth quarter.

The reading translates into a quarterly contraction of 0.5%, versus a 0.4% decline expected by economists.

Private consumption, which accounts for more than half of the Japanese economy, fell 0.7%, bigger than the forecast 0.2% drop. It was the fourth straight quarter of decline, the longest streak since 2009.

“Japan’s economy hit the bottom in the first quarter,” said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities. “The economy will certainly rebound this quarter thanks to rising wages although uncertainty remains on service consumption.”

Capital spending, a key driver of private demand, fell 0.8% in the first quarter, versus an expected decline of 0.7%, despite hefty corporate earnings.

External demand, or exports minus imports, knocked 0.3 of a percentage point off first quarter GDP estimates.

Policymakers are counting on rising wages and income tax cuts from June to help spur flagging consumption.

The drag to growth from an earthquake in the Noto area this year and the suspension of operations at Toyota’s (TM) Daihatsu unit are also expected to fade.

Still, a sharp decline in the yen to levels unseen since 1990 has fueled concerns about higher living costs, squeezing consumption.

The Bank of Japan (BOJ) raised interest rates in March for the first time since 2007, in a landmark shift away from negative rates, but the central bank is expected to go slow in unwinding easy money conditions given a fragile economy.