Japan's economy shrank an annualized 2 percent in real terms in the first quarter of this year, marking the first contraction in two quarters, primarily due to sluggish consumer spending.

Adjusted for inflation, the real gross domestic product in the first quarter dropped by 0.5 percent compared to the previous quarter. Preliminary data from the Cabinet Office released on Thursday indicated a 0.7 percent decrease in personal consumption during the January-March period, a significant factor as it comprises over half of Japan's GDP.

Domestic demand suffered from increased inflation and a suspension in vehicle shipments stemming from a safety test manipulation scandal at Daihatsu Motor Co, a subsidiary of Toyota Motor Corp.

Capital spending also saw a decline of 0.8 percent, the first decrease in two quarters, with Japanese companies reducing investments in machinery and auto-related sectors following the Daihatsu scandal.

Estimates from the International Monetary Fund released in April forecast Japan's nominal GDP for 2025 to stand at $4.31 trillion, positioning it below India's $4.34 trillion and dropping Japan to the world's fifth-largest economy.

Earlier projections suggested this shift would occur in 2026, but the depreciation of the yen accelerated the timeline by a year.

Financial markets anticipate the Bank of Japan to raise interest rates later this year, as there is growing pressure on the central bank of Japan to counteract the yen's weakening trend.