Japan’s economic growth trounced expectations in the fourth quarter, surprising economists and the market and increasing the odds of interest rates being upped sooner.

In the October-December period, the country's gross domestic product grew by an annualized 2.8%, far more than a 1% forecast by a Reuters poll.

It was the third consecutive quarter in positive territory. In the July-September period, the GDP increased at an annualized rate of 1.7%, and that followed a 3% increase in the second quarter.

Exports received credit for the strong showing in the fourth quarter, although economists also noted that weak domestic demand was a drag on performance.

Private consumption — which accounts for more than a half of GDP — was up 0.1% in the fourth quarter. With inflation high — hitting 3.6% in December — consumers have been reluctant to spend.

Exports rose 1.1%, marking a third consecutive quarter of increases, while imports declined 2.1% on weak domestic demand.

“The GDP figure was significantly stronger than market expectations, but it can be mostly explained by an upside surprise in external demand,” Toru Suehiro, chief economist at Daiwa Securities, wrote in a report Monday. “The weakness of domestic demand is within market expectations and my expectations."

Although the country’s GDP grew for a third straight quarter, private consumption is still weaker than before the pandemic, Taro Saito, head of economic research at NLI Research Institute, noted in a report released on the same day.

He added that it would still take some time for consumer spending to recover.

Saito projects Japan’s GDP to continue to grow in the January-March quarter.

"But due to factors such as higher-than-expected inflation, downside risks remain high, particularly in private consumption,” he wrote.

After the GDP report was released Monday morning, Japan’s currency strengthened. It went from about ¥152 to the dollar to about ¥151.5, and remained in positive territory throughout the day. The yen has been rallying since last week, when a strong wholesale inflation figure provided support for rate hawks.

In January, the Bank of Japan revised its price outlook for the year starting April to a 2.4% increase in consumer prices, excluding fresh food, up from the 1.9% forecast in its October quarterly report.

The BOJ explained that the upward revision is mainly due to cost-push factors, such as increases in import prices due to the yen’s weakening. The bank said that more expensive rice is also driving inflation.

BOJ Gov. Kazuo Ueda told parliament last week that the central bank is aware that high food prices are negatively affecting households. For Japan to realize sustainable economic growth, pay increases in spring wage negotiations are seen as key.

The Japanese Trade Union Confederation is seeking pay increases of more than 5% at large companies and more than 6% at smaller companies. Many economists believe that the 6% target will be difficult to achieve.

Real wages in the country declined for a third consecutive year in 2024 as inflation continued to outpace pay increases. Inflation-adjusted pay including bonuses fell 0.2% in 2024. Real wages rose 0.6% in December year on year due to seasonal bonuses.

Some economists project that Japan’s real wages will likely rise on a consistent basis later this year, as inflation is expected to cool and companies are expected to offer robust wage increases.

A number of uncertainties remain, such as the economic policies of U.S. President Donald Trump.

Government data also show that Japan’s GDP grew 0.1% for the full year of 2024, compared with a 1.5% increase in 2023.