Fitch forecasts Japan's GDP growth to moderate to 0.7% in 2026, 2027

The 'A' rating balances the strengths of an advanced, wealthy economy with correspondingly robust governance standards and public institutions, against weak medium-term growth prospects and very high public debt.

Bond yields continue to rise amid monetary tightening and Fitch Ratings forecasts fiscal deficits to rise steadily, but now-entrenched inflation and a strong fiscal performance in recent years should keep debt on a slightly downward trend and mitigate fiscal risks from a ratings perspective.

Persistent current account surpluses, a large external asset position and the yen's reserve currency status also support the rating, Fitch said in a release.

Key rating drivers are political uncertainty, a projected rise in fiscal deficit, more expansionary fiscal stance, manageable higher rates, resilient inflation, more monetary tightening in future and a projected steady gross domestic product (GDP) growth.

Potential snap election in February may inject near-term political uncertainty into the policy outlook. However, there would be greater policy clarity if a government emerges with a larger majority.

Fitch Ratings forecasts fiscal deficit to rise to 2.4 per cent of GDP in fiscal ending March 2026 (FY26) from a 33-year low of 1.4 per cent in FY25. Buoyant revenues, driven by stronger nominal GDP growth, will continue to support the fiscal position. It expects the fiscal deficit to rise towards 3.7 per cent of GDP by FY28.

The fiscal outlook is uncertain and risks remain that fiscal policy could be more expansionary than it projects.

Financing costs for the government continue to rise, but will affect the government debt outlook only gradually, given an average debt maturity of over nine years.

Fitch forecasts government debt to stay elevated in the medium term, but on a downward trend as higher nominal GDP sufficiently offsets larger fiscal deficits and rising financing costs.

It expects inflation to remain entrenched, though we forecast a slight easing in headline inflation to 2.3 per cent by end-2026 from around 3 per cent now.

Cost-of-living relief provided in a recent supplementary budget will temporarily lower inflation, but Fitch Ratings expects stronger wages, recent yen depreciation and the expansionary fiscal stance to keep inflation above 2 per cent in the next couple of years.

The rating agency feels Japan's credit profile benefits on a net basis from a stronger inflation outlook, despite pressure on public finances from higher interest rates.

Higher inflation, particularly combined with a weakening yen, will provide impetus for the central bank to press ahead with further rate hikes in the coming quarters. It expects the policy rate to reach 1.5 per cent by end-2026 from 0.75 per cent following the BOJ's latest 25-basis point hike in December 2025.

Fitch forecasts GDP growth will moderate to 0.7 per cent in 2026 and 2027, in line with its estimate of potential growth, from a forecast of 1.3 per cent in 2025. The economy will be underpinned by continued solid capital expenditure demand and real wage growth, as well as an expansionary fiscal stance.

Japan has weathered US tariff-related headwinds relatively well, but even with the recent trade agreement net trade will remain broadly neutral for growth in 2026, it adds.

Fibre2Fashion (DS)