Bank of Japan Board Member Naomi Nakagawa stated on August 28, 2025, that significant uncertainty remains regarding U.S. tariff policies and their impact on the Japanese and global economies. This uncertainty is emerging as one of the largest external risks to Japan’s economy, compelling the central bank to exercise heightened caution in its monetary policy decisions.

Since the interest rate hike in January 2025, the Bank of Japan has maintained the policy rate at 0.5%, primarily due to concerns over the damaging effects of U.S. tariffs on economic growth. Nakagawa emphasized that the upcoming September “Tankan” business sentiment survey will be critical, as it will assess how progress in trade negotiations among major economies has affected corporate confidence. The manufacturing sector sentiment index is expected to hold around 13, while the non-manufacturing index may dip slightly to 27, reflecting the permeation of trade uncertainty throughout the economy.

Should the survey reveal a further deterioration in business confidence, the Bank of Japan may be forced to delay any plans for additional rate hikes, thereby exacerbating the fragility of Japan’s economic recovery.

Japan-U.S. Trade Talks Make Slow Progress

Japanese Trade Negotiator Yoshimasa Akazawa canceled his visit to the United States scheduled for August 28, 2025, due to administrative delays that prevented the finalization of details regarding the investment agreement.

The agreement originated from a July 2025 pact in which Japan committed to providing $550 billion in investments to the United States through government-backed loans and guarantees, in exchange for Washington reducing tariffs on Japanese imports to 15%.

However, on August 26, U.S. Commerce Secretary Howard Lutnick stated that while investment details would be announced later in the week, working-level issues remained unresolved. Japanese officials insisted on amending the U.S. Presidential Executive Order first to eliminate overlapping tariffs on goods such as beef before issuing a joint document.

A government source revealed that if the issues are resolved, Akazawa may visit the United States early next week. The U.S. is considering revising the Executive Order dated July 31, 2025, to ensure that the 15% tariff rate does not overlap with higher tariffs on specific products. Additionally, plans are underway to reduce tariffs on Japanese automobiles to 15%, though a specific timeline has not yet been determined.

Economic Impact of Tariffs

Since the White House initiated its "America First" trade policy in April 2025, the United States has imposed a 15% "reciprocal tariff" on Japanese goods, which has already had a noticeable impact on Japan's economy.

Data from Japan’s Ministry of Finance show that overall exports in July 2025 fell by 2.6% year-on-year, the largest decline in over four years. Exports to the U.S. dropped for the fourth consecutive month, decreasing by 10.1%. Automobile exports plummeted by 28.4% to ¥422 billion, with export volume declining by 3.2% to 123,500 vehicles. Exports of auto parts and semiconductor equipment also saw significant decreases.

According to a Nikkei survey of 1,069 companies listed on the Tokyo Stock Exchange First Section, corporate net profit in the second quarter of this year declined for the first time in three years, falling by 12% year-on-year to ¥12.3 trillion. The automotive and auto parts sectors were hit particularly hard, with profits dropping by approximately ¥980 billion, a decline of 45%. Overall, real GDP growth for fiscal year 2025 is projected to be just 0.7%, well below potential growth rates, indicating that U.S. tariff policies have significantly increased downside pressures on Japan’s economic expansion.

More critically, the World Trade Organization estimates that U.S. government tariff measures will reduce global merchandise trade volume by 1% in 2025. Meanwhile, Bloomberg’s Global Trade Policy Uncertainty Index has risen to its highest level since 2009, further amplifying external pressures on Japan’s economy.

Beyond these macroeconomic effects, the tariff policy has inflicted damage across multiple Japanese industries, with the automotive and auto parts sectors bearing the brunt. Japanese auto exports to the U.S. still face a high 27.5% tariff, and the agreed reduction to 15% has not yet been implemented. As a result, second-quarter profits in the sector collapsed by 45%, amounting to a loss of approximately ¥980 billion.

Honda’s net profit fell by 50%, while Toyota expects operating profit to decrease by ¥1.4 trillion this fiscal year. Mazda reported a 9% decline in first-quarter sales, with a net loss of ¥42.1 billion, and forecasts an 82% plunge in net profit for fiscal year 2025. The steel industry also fell into a loss in the second quarter, with Tokyo Steel Manufacturing revising down its earnings forecast for fiscal 2025 due to rising costs and weak demand, which squeezed profit margins.

Source: Mazda

The chemical industry likewise experienced declining profits. The CFO of Mitsubishi Chemical Group stated that tariffs have led to a collapse in customer confidence, with the negative impact far exceeding expectations. Small and medium-sized enterprises (SMEs) have been particularly affected. A survey conducted by the Osaka Chamber of Commerce and Industry at the end of July revealed that 11% of SMEs have already been impacted, while 50% are concerned about order cancellations—an increase of 12 percentage points since April. For example, a Kyoto-based food exporter saw a 30% drop in sales to the U.S. in the second quarter as American importers cut orders due to tariff concerns. These industry losses not only undermine Japan’s economic competitiveness but also risk triggering large-scale job losses and supply chain disruptions.

Monetary Policy Dilemma

Facing tariff shocks, the Bank of Japan's monetary policy is caught in a dilemma. After ending negative interest rates in March 2024 and raising rates to 0.5% in January 2025, the central bank paused further adjustments primarily due to tariff-related uncertainties. Governor Kazuo Ueda indicated that the central bank may take action if tariffs significantly harm economic growth, suggesting a potential halt in its rate hike cycle. According to forecasts by Oxford Economics, the policy rate is likely to remain unchanged throughout 2025–2026.

Source: TradingEconomics

Tariffs could lower inflation expectations through two channels: reduced exports dampening economic growth, and a stronger yen—potentially appreciating toward 130 per dollar—squeezing corporate profits, undermining investment and wage growth.

Goldman Sachs warned that if the yen continues to strengthen amid a deteriorating inflation outlook, the BOJ would have little choice but to pause rate hikes. A Reuters poll in August showed that two-thirds of economists expect the central bank to raise rates by at least 25 basis points, though this depends on eased trade tensions. Such policy uncertainty amplifies global market volatility and could threaten Japan’s financial stability.

Sharp Volatility in Financial Markets

Japan's financial markets have undergone intense fluctuations under the impact of tariff pressures.

Since the start of 2025, Japanese stocks have continued to fall, declining for three consecutive months with a cumulative quarterly drop of 10%, ranking at the bottom among major Asian stock indices and marking the worst quarterly performance since March 2020. On March 31, the Nikkei 225 index plunged 4.05%, losing over 1,500 points in a single day and breaking below the 36,000 point mark.

In April, the Nikkei average once fell to 31,136 yen, but the Japanese stock market quickly rebounded. Since the low point in April 2025, the Nikkei 225 index achieved a dramatic reversal within just 64 trading sessions, not only recovering all losses but also reaching a new historical high of 42,867 points on August 12. As of August 25, the Nikkei 225 opened up 373.89 points, a gain of 0.88%, at 43,007.18 points.

Source: TradingView

However, stocks in the automotive and retail sectors plummeted. Fast Retailing (parent company of Uniqlo) plunged 6.9% due to tariff impacts, while Mitsubishi Heavy Industries and SoftBank Group also experienced significant declines. The earlier decline stemmed from tariff uncertainty and yen appreciation, while the subsequent rebound was driven by a shift in trade policy, better-than-expected corporate earnings, and capital inflows. Overall, however, high stock market volatility highlights the damage tariffs have inflicted on investor confidence.

The performance of the bond and foreign exchange markets similarly reflects the uncertainty surrounding tariff policies. In early April, when tariff measures were first implemented, the yield on 10-year Japanese government bonds fell to 1.05%, the lowest level in 2025, indicating increased risk-aversion sentiment.

Source: TradingView

The yen exchange rate exhibited two-way volatility, swinging repeatedly between safe-haven demand and policy expectations. Between August 21 and 28, it fluctuated within a range of 146 to 148 yen per U.S. dollar, depreciating about 3% compared to the beginning of the year, reflecting a market repricing of Japan’s economic fundamentals.

Source: TradingView

Conclusion

U.S. tariff policies have already significantly impacted Japan's economy, manifesting in sharply reduced exports, declining corporate profits, constrained monetary policy, and stock market turbulence. Although the U.S.-Japan agreement offers partial relief, unresolved issues and global trade uncertainties are likely to continue exerting pressure.

The Bank of Japan must rely on data such as the Tankan survey to make cautious decisions, while the government needs to promote industrial diversification to reduce reliance on the U.S. market. Otherwise, such external shocks will continue to constrain Japan’s economic growth over the long term, forcing policymakers to undertake fundamental adjustments.