UPDATE 4-Japan's solid Q1 GDP faces reality check as Iran war threatens economy

In a statement ⁠issued after the GDP data, Economy Minister Minoru Kiuchi urged vigilance over the drag from the Middle East war. "The outlook for the coming quarters looks incredibly challenging," with the conflict pushing up commodity prices and inflation keeping real wage growth slow, said Stefan Angrick, head of Japan and Frontier Markets Economics, Moody's Analytics.

​Japan's economy grew faster than expected in the first quarter on solid exports and consumption, data showed, though momentum will face a severe test as the full force of the energy shock from the Iran war filters through businesses and consumers.

The data will be one of the key factors the Bank of ‌Japan will scrutinise in determining whether the economy can withstand the energy crisis, and allow it to raise interest rates as soon as next month. "Today's data shows the economy was on a solid footing before the Iran war, which means it has some buffers to weather the energy shock," said Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute.

"The economy may contract in the second quarter but if it's just about prices rising overall, it can ‌probably resume a recovery thereafter. If there's huge supply disruptions, the damage to growth could be so severe the BOJ may not have scope to raise interest rates in June," he said. Japan's real gross ‌domestic product (GDP) increased an annualised 2.1%, data showed on Tuesday, outstripping the median market forecast for a 1.7% gain and a revised 0.8% rise in the previous October-December quarter.

The second straight quarter of expansion in the world's fourth-biggest economy was underpinned by solid exports with net external demand adding 0.3 percentage point to growth, the data showed. Private consumption and capital expenditure both grew 0.3% from the previous quarter, suggesting that robust corporate profits and steady wage gains were supporting the recovery.

But analysts expect growth to slow in the coming quarters ⁠as the fallout from ​the Middle East conflict, which has caused an unprecedented ⁠disruption to global energy supplies, intensifies. "We think the Q1 GDP is already in the rear-view mirror and expect the economy to feel the strains from high energy costs ahead. Higher energy prices and elevated uncertainty will limit consumption and investment in the near term," ⁠analysts at Oxford Economics wrote in a research note.

Markets largely shrugged off the GDP data, with attention instead focussed on U.S. President Donald Trump's decision to halt a planned strike on Iran, leaving Asian stocks directionless and bonds on firmer ground. Safe-haven ​demand for the dollar pushed the yen down to 159 per dollar, keeping traders on alert for the chance of yen-buying intervention by authorities. Tokyo is suspected to have spent roughly 10 trillion ⁠yen in the latest bout of intervention to shore up the embattled Japanese currency, as its sustained weakness fans inflationary pressure through costlier imports.

'DIFFICULT YEAR' AHEAD U.S.-Israeli strikes on Iran in late February and Tehran's effective closure of the Strait of Hormuz, which normally carries a fifth of ⁠global ​oil and gas, have sent prices soaring and raised fears of a major disruption to energy flows.

Japan's heavy reliance on Middle Eastern oil leaves it acutely exposed. Rising fuel costs are stoking inflation, eroding household purchasing power and tightening corporate margins, a combination that heightens the risk of a severe economic downturn if disruptions persist. The shift in the outlook is already rippling through policy expectations. The BOJ has dialled up hawkish signals ⁠that had prompted markets to price in a strong chance of an interest-rate hike in June.

The government, for its part, will compile an extra budget to cushion the economic blow from soaring fuel costs, a ⁠move that would strain Japan's already worsening finances. In a statement ⁠issued after the GDP data, Economy Minister Minoru Kiuchi urged vigilance over the drag from the Middle East war.

"The outlook for the coming quarters looks incredibly challenging," with the conflict pushing up commodity prices and inflation keeping real wage growth slow, said Stefan Angrick, head of Japan and Frontier Markets Economics, Moody's Analytics. "Modest fiscal ‌support for households, defence and strategic investment ‌should keep the economy from derailing, but the growing list of headwinds points to a difficult year."