Japan’s latest economic figures may look modest compared with the much larger concerns facing the global economy, but they deserve considerably more attention. Japan is not in recession: real GDP grew at an annualized rate of 1.1% in the second quarter of 2026, or 0.3% from the previous quarter. Yet the expansion was significantly weaker than the 2% annualized growth expected by economists. Private consumption weakened, capital investment fell 1.2%, while external demand provided support.

The immediate problem is therefore not that Japan is contracting, but that its growth is becoming increasingly dependent on external demand while domestic demand remains fragile. Rising energy costs, partly linked to the conflict in the Middle East, have put additional pressure on Japanese households and companies. The weak yen has helped exporters by increasing the yen value of their overseas earnings, but it has simultaneously made imported energy and other goods more expensive for consumers. This combination makes Japan’s economic policy dilemma particularly difficult.

What makes Japan important to the rest of the world, however, is not simply its GDP growth. It is the country's enormous role in global finance.

For decades, Japan has been one of the world's most important sources of cheap money. Extremely low Japanese interest rates encouraged investors to borrow in yen and invest the proceeds in assets offering higher returns elsewhere. This strategy, known as the yen carry trade, does not mean that investors put all the money into the United States. US equities and Treasury bonds are major destinations, but the strategy can also involve European assets, Australian........

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