Japan is likely to offer concessions on tariffs and purchase agreements, while trying to keep deeper issues such as currency and defense off the table.

Either way, trade uncertainty will keep the Bank of Japan (BoJ) on hold for the rest of this year.

Japan as a roadmap for other trade negotiations

Now that the Trump administration has managed to box-tick one easy trade negotiation win (the UK) and make headway with the toughest negotiator (China), focus turns to the next group. Japan, South Korea, and India were among the first to begin talks, with expectations that they will strike “deals” well before the first 90-day tariff moratorium expires.

Japan makes an interesting case study for the other nations. It is one of the closest economic and political Asian allies of the US, a large investor into US manufacturing, and occupies a central position in the global value chain.

An amicable start gives way to a more defiant stance

On April 2, Japan faced a 10% universal tariff, a 24% country-specific "reciprocal" tariff, and a 25% tariff on autos and parts.

Japan did not retaliate like China and the EU. Instead, they dispatched a trade delegation to Washington and responded via domestic policy. Fuel and electricity subsidies and corporate financing support were announced to counteract any economic hit.

By mid-April, US officials' tone had turned negative. Treasury Secretary Scott Bessent emphasized the need to address the weak yen, implying currency manipulation was at play.

President Trump labeled the US-Japan security treaty as “one-sided” to maximize trade concessions and increase Tokyo’s defense payments. But by early May, Japan and the US agreed to expedite tariff negotiations to come to an agreement on a Memorandum of Understanding (MoU) by June, well ahead of the July 9 expiration of the 90-day reprieve.

However, the tone from the Japanese side has since hardened. As Finance Minister Katsunobu Kato mentioned in an interview, there were thinly veiled threats of using US Treasury holdings as leverage in trade talks.

Japan has also stressed that trade talks must be kept separate from issues such as currency and defense.

US-China talks are likely to have emboldened Japan to push back on more aggressive calls from the US. Furthermore, China lifting the critical minerals export ban to the US will alleviate tension for Asian semiconductor manufacturers caught tiptoeing between the US and China.

Principal areas of discussion and waymarks to watch

At the time of writing, Japan’s top trade negotiator, Ryosei Akazawa, was holding firm. Determined to protect the agricultural sector from US imports and pushing for complete removal of all tariffs imposed, including autos and parts, as well as the baseline 10% “reciprocal” tariff. Bloomberg quoted Akazawa as having remarked that it would be “beneficial to communicate with other nations on tariffs.”

There is no evidence of regional coordination yet. However, Japan is influential across APAC and could pose an additional challenge for the US if several countries were to coordinate a response.

Based on the current trajectory of talks, the principal areas of discussion are likely as follows:

An important waymark will be who participates in discussions

Early discussions in April saw Japan’s Chief Trade Negotiator Ryosei Akazawa and US Treasury Secretary Scott Bessant leading the respective teams.

However, in the latest APEC meeting, Japan sent junior negotiators to meet with US Trade Representative Jamieson Greer, signaling little intention of meaningful talks.

When can we forecast with confidence?

Phase 1

The current landscape has limited visibility. Key variables remain unresolved, so macro forecasts beyond the next quarter remain speculative. The BoJ has flagged risks in either direction for the economic assumptions.

Phase 2

The period between June and September should bring greater clarity. By this point, some framework agreement is expected, which should clarify the magnitude of tariffs, trade quotas, and initial plans for supply-chain security across chips and critical materials.

The government plans to submit additional economic stimulus measures before the July upper house elections. These measures are expected to be implemented by autumn.

Phase 3

Greater forecasting confidence should be expected by late 2025, especially if operational trade rules, tariff schedules, and enforcement mechanisms are in place.

The BoJ should, at that point, be able to start communicating a more straightforward monetary policy path.

Q1 GDP was weaker than the consensus and contracted by 0.2% quarter over quarter. Consumption was flat, but net trade was a significant drag. However, business investment remained resilient. Structural demographic challenges have encouraged corporations to invest in labor-saving automation. Software investment accounts for about 10% of capital expenditure yearly and should support growth over the coming years.

Going forward, GDP will also receive fiscal support through a supplementary budget. Ahead of the upper house election on July 22, increased pressure exists to lower the consumption tax. Historically, these have proved difficult to reverse, so we expect the government to consider other fiscal measures, such as support for households to counter inflation and corporations to counter the tariff shock.

We expect trade uncertainty to drag on growth over the short term, but the impact should be short-lived and shallow.

The outlook for medium-term inflation will become clearer. The feedthrough of Shuntō wage negotiations into realized wages and inflation will be clearer. Food inflation has driven recent inflation pressures, while core services inflation remains subdued (Chart 1).

Carefully timing the next BoJ move

Amid this uncertainty, in the May monetary policy meeting, BoJ Governor Kazuo Ueda stressed a lack of confidence in the central bank’s own forecasts. Credible growth and inflation forecasts are unlikely until a comprehensive trade framework with reciprocal and sector tariffs is agreed.

While the BoJ can begin incorporating deal parameters by the end of the third quarter of 2025, it is unlikely to rely on forecasts until at least the fourth quarter.

The domestic political timetable will also likely influence the timing of the next rate hike. The upper house elections are due to be held in July. The Liberal Democratic Party (LDP) remains in the lead, albeit with weaker polling in recent weeks.

A supplementary budget is expected in autumn, while a budget bill is expected to be debated in December. The prospect of this deficit expansion, alongside building worries about the US fiscal position, is a reason why long-end Japanese government bond (JGB) yields have been rising sharply in recent days. Demand has dropped against the backdrop of heavy long-end JGB issuance.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

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