Uncertainty stares at Japan amid oil woes

Japan's economic outlook is facing growing uncertainty as elevated global oil prices and instability in the Middle East continue to fuel inflation and weigh on domestic demand, analysts said.

Data released by Japan's Cabinet Office on Tuesday showed the country's real gross domestic product expanded at an annualized rate of 2.1 percent in the first quarter, above market expectations of around 1.6 percent, marking a second consecutive quarter of growth.

Despite the stronger-than-expected GDP growth, Japanese financial markets weakened following the data release, with the benchmark Nikkei 225 index falling 0.64 percent, while yields on 10-year Japanese government bonds edged higher. The yen also weakened slightly against the US dollar to 158.95.

Economists warned that the impact of rising oil prices and tensions between the United States and Iran is likely to become more visible from the second quarter onward.

Takahide Kiuchi, executive economist at Nomura Research Institute, said that although first-quarter GDP growth slightly exceeded expectations, the more serious challenge lies in the potential economic fallout from sustained geopolitical tensions and surging energy prices.

According to Kiuchi, if tensions surrounding Iran persist and shipping through the Strait of Hormuz remains effectively disrupted, Japan could face prolonged shortages of crude oil and naphtha, forcing manufacturers to cut production and leading to supply shortages and sharp price increases.

He warned that such developments could push the Japanese economy closer toward stagflation.

Other economic indicators released before the GDP data also pointed to mounting pressure on the economy. Household spending in March fell 1.3 percent from the previous month, while separate government surveys showed weak consumer confidence in both March and April.

Industrial production declined 0.5 percent month-on-month in March, partly due to reduced output in the chemical sector amid concerns over disruptions in naphtha supplies.

Under pressure

Norihiro Yamaguchi, senior economist at Oxford Economics, said in an interview with CNBC that although Japan's first-quarter growth appeared relatively solid, the economy is expected to come under pressure from persistently high energy costs in the coming months.

Yamaguchi noted that while export growth may provide some short-term support, rising energy prices and growing uncertainty are likely to weigh on consumption and business investment.

Uncertainty surrounding the Middle East situation has also increased volatility in Japan's government bond market.

According to Nikkei Asia, yields on 10-year Japanese government bonds climbed 10 basis points to 2.8 percent on Monday, the highest level since October 1996, as inflation and fiscal concerns triggered a sell-off in sovereign debt. Yields on 30-year and 40-year JGBs also hit record highs, while the 5-year bond yield rose to 2 percent.

Kiuchi said the continued rise in long-term interest rates has heightened concerns about potential impacts on economic growth, stock markets and the financial health of financial institutions.

He said rising oil prices have increased global inflation risks, while speculation over additional government spending to cushion the impact of higher energy costs has also fueled concerns about Japan's fiscal position and pushed bond yields higher.

According to Nikkei Asia, the Japanese government is considering a supplementary budget to help ease the burden of soaring energy prices on households. Prime Minister Sanae Takaichi said on Monday that she had instructed officials, including the finance minister, to explore funding options, including additional budget measures, for further subsidies.