Japan's GDP was revised downward to a contraction of 2.9% in July-September, weighing on inflation

Japan's economy shrank 2.9 percent in real terms on an annual basis in July and September, more than the 2.1 percent previously reported, weighed down by weaker-than-expected private consumption and slowing export growth, government data showed on Friday.

Inflation-adjusted real gross domestic product fell 0.7 percent from the previous quarter, compared to a previous forecast of a 0.5 percent decline.

The world's third-largest economy posted its first negative growth in four quarters. GDP is the total value of goods and services produced in a country.

Private consumption, which accounts for more than half of GDP, fell 0.2 percent instead of 0.04 percent as rising prices for everyday goods dampened household sentiment.

Capital investment, another key indicator of domestic demand, was revised down to a decline of 0.4 percent from the previous figure of 0.6 percent.

“Although the underlying recovery trend is not yet over, both private consumption and capital spending were weak in the GDP data. Caution is advised,” said Yoshimasa Maruyama, chief economist at SMBC Nikko Securities.

“Inflation has a negative impact on households as wage growth is more than offset by rising prices. It will take time for (inflation-adjusted) wage growth to turn positive,” Maruyama said

Weakening domestic demand poses a challenge for the government as it tries to ease the burden on consumers from more expensive everyday goods and falling wages.

The slowing economy is giving the Bank of Japan reason to maintain ultra-low interest rates. However, as headline inflation has been above the central bank's long-term target of 2 percent for more than a year, it is becoming increasingly difficult for the public to accept this view that the inflation target has not yet been achieved in a stable manner through wage growth.

Exports grew 0.4 percent, slightly slower than the 0.5 percent in the preliminary data, while imports rose 0.8 percent, a downward revision of 1.0 percent.

Nominal GDP was revised up slightly from a decline of 0.2 percent to fall 0.05 percent on an annual basis.

Robust exports had supported the economy in previous quarters, although aggressive interest rate hikes in major economies questioned the sustainability of strong export growth. China's economic slowdown has become another cause for concern.

While BOJ Governor Kazuo Ueda has underscored the need to maintain monetary easing, his comments on Thursday that it would become even more “challenging” from the end of the year through 2024 fueled market speculation that an exit will come sooner than expected. The yen then rose sharply against the US dollar.

SMBC's Maruyama expects the economy to recover in the October-December quarter, but the BOJ will take a wait-and-see approach ahead of annual wage negotiations between unions and management next spring.

Prime Minister Fumio Kishida has highlighted the risk that without sustained wage growth, Japan will slip back into deflation or that prices will continue to fall.

Later this month, the government will prepare a budget for the next fiscal year starting in April, in addition to the recently passed 13.20 trillion yen ($92 billion) supplementary budget for fiscal 2023 to include anti-inflation measures such as subsidies, implement lower fuel costs and payouts of 70,000 yen to low-income households.

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