(May 16): Japan’s economy contracted in the first quarter as consumers and companies reduced spending, underscoring the fragile nature of the recovery and extending a dismal performance stretching back to last summer.

Gross domestic product shrank at an annualised pace of 2% in the three months through March, the Cabinet Office said Thursday. Economists had forecast a contraction of 1.2%. Private consumption and capital spending both retreated, while net exports also exerted a drag on growth. Data for the last quarter of 2023 were revised to show a flat result, versus a previous positive annualised reading of 0.4%

The data reflected the negative impact of a New Year’s Day earthquake northwest of Tokyo and disruptions to auto production and sales after a certification scandal blew up at Daihatsu Motor Co, a subsidiary of Toyota Motor Corp. Other factors dragging on growth included a steady decline in household spending, as workers contending with persistent declines in real wages tightened their budgets.

The weak results come as the central bank is looking closely at data to determine when it should next raise interest rates after it conducted its first hike in 17 years in March.

Many economists expect the Bank of Japan (BOJ) to move again later this year. They forecast an economic rebound in the quarter through June, as auto output recovers and the wage hikes lift consumer sentiment. Many families will also receive one-off tax cuts starting in June.

While the first-quarter data painted a gloomy picture for the economy, there were positive developments as well. The first quarter saw companies emerge from annual negotiations with unions pledging the largest wage hikes in three decades. The prospect of higher pay eventually boosting consumption was a factor behind the BOJ’s decision to raise interest rates in March.

It remains to be seen if consumer spending will pick up strongly. Subsidies to cap rising utilities costs are set to end at the end of May, and the yen’s weakness is weighing on sentiment across a wide range of service industries.

Japanese authorities and business executives have voiced concerns over the currency’s weakness, which has put pressure on households and small companies by inflating costs for imported energy and other materials even as exporters including Toyota post robust results.

The BOJ currently expects cost-push inflation to continue to ease and transition into demand-driven price rises. Governor Kazuo Ueda said the central bank would consider taking action if foreign exchange moves have a big impact on the inflation trend.