The Japanese economy is sliding into recession and ranks fourth in the global rankings

Japan's economy contracted at the end of last year, defying modest growth expectations and pushing the country into recession.

Japan's unexpected economic weakness in the fourth quarter was the result of slowing business spending and consumers grappling with inflation at its highest levels in four decades, a weak yen and rising food prices.

The end of the year was also the moment that had been expected: Japan's economy, now slightly smaller than Germany's, fell one notch to become the world's fourth largest.

On an annual basis, GDP fell by 0.4 percent in October through December after a revised decline of 3.3 percent in the previous three months. Economists had expected growth in the fourth quarter of about 1 percent.

These numbers cloud the outlook for the Japanese economy. Corporate profits are at record levels, the stock market is rising, and unemployment rates are low. But consumer spending and business investment — two key drivers of the economy — are lagging.

The economy is “polarized” because of rising prices, said Shinichiro Kobayashi, chief economist at Mitsubishi UFJ Research and Consulting. He added that when corporate profits jump, commodity prices also rise, but wages have not continued to rise and consumers are reluctant to spend.

The big question is whether Japanese workers will be able to achieve a significant wage increase this year.

“The ball is in the corporate sector’s court,” Kobayashi said.

Two consecutive quarters of negative growth mean the economy is technically in recession, but the numbers are preliminary. A large enough revision upward could invalidate the designation of a recession.

Weak economic data also complicates the Bank of Japan's upcoming decision on whether to go ahead with the country's first interest rate increase since 2007.

The Bank of Japan has stubbornly maintained policies aimed at keeping interest rates low and stimulating spending – a remnant of its long-running fight against deflation. Many economists have speculated that the central bank may finally change course as early as April if the economy appears to be in a stronger position.

Marcel Thiliant, head of Asia Pacific at Capital Economics, wrote in a research note that he “doubts” that disappointing fourth-quarter numbers will prevent the Bank of Japan from ending negative interest rates in April even though economic growth will remain “sluggish” this year. year.

One thorny issue for the central bank remains the persistent weakness of the Japanese yen. The decline in the purchasing power of the currency means the cost of goods imported into Japan increases, which increases the inflationary pressures felt by consumers. However, it tends to help the bottom line of many leading Japanese companies that sell goods abroad and bring those foreign profits back to the country in yen.

By holding steady over the past two years even as the European Central Bank and the Federal Reserve raised interest rates, the policies pursued by the Bank of Japan have exacerbated the yen's weakness. This has made it attractive for global investors to borrow yen at very low interest rates in Japan and then invest that money in dollars or euros at much higher interest rates in the West.

Saisuke Sakai, chief economist at Mizuho Research and Technology Co., said it seemed likely that the domestic economy would contract again in the first three months of this year due to disruptions caused by the major earthquake that struck western Japan in January – a region rich in manufacturing.

This could hurt consumer sentiment further.

“If we have three consecutive quarters of negative growth, people will wonder: Is the Japanese economy really in good shape?” Sakai said.

With the release of year-end GDP figures, Japan also relinquished its position as the third-largest economy after the United States and China, a position it had held since China overtook it in 2010. Germany now enjoys this distinction with respect to the US dollar, the main currency used in global trade and finance.

In fact, the German economy is also faltering. Germany's decision to stop buying cheap Russian natural gas and oil after Russia's invasion of Ukraine caused energy costs to rise sharply, even as Germany turned to suppliers in the Middle East, the United States and elsewhere.

In the coming years, Japan may lose its grip on fourth place, as its shrinking population will struggle to keep pace with growth in India, the world's most populous country.

Keith Bradsher Contributed to reports.