Japan factory output contracts, dims growth outlook as tax hike looms

By Tetsushi Kajimoto and Stanley White TOKYO (Reuters) - Japan's factory output unexpectedly fell in February at the fastest pace in eight months, leaving the economy in a precarious position as an impending sales tax hike threatens to choke consumption and undermine the government's revival plan. Analysts say that with the national sales tax rising to 8 percent from 5 percent on Tuesday, the Bank of Japan will probably need to inject more stimulus to safeguard a recovery amid a recent loss of momentum. Ministry of Economy, Trade and Industry (METI) data showed on Tuesday industrial output fell 2.3 percent in February from the previous month, versus a 0.3 percent rise seen by economists in a Reuters poll. That followed a solid 3.8 percent gain in January, which was driven by brisk production of cars and household appliances. Manufacturers surveyed by the ministry expect output to rise 0.9 percent in March but decrease 0.6 percent in April, the METI said, shrugging off the weak February reading as a one-off factor due to unusually heavy snow that disrupted factory activity. Still, analysts said the outlook for the economy remains challenging at best, noting a recent string of soft data and a separate survey on Monday showing manufacturing activity grew at a slower pace in March. "Companies are curbing production to keep inventories low because they are worried about demand after the sales tax hike," said Norio Miyagawa, senior economist at Mizuho Securities Research & Consulting Co. "This suggests the economy may not rebound quickly, and the burden may fall on the BOJ as the government has already committed to fiscal stimulus spending." Japan's economy sped past its developed country peers in the first half of last year, spurred by Tokyo's aggressive fiscal and monetary stimulus, but has since slowed steadily as exports and capital spending lagged. With the data indicating the benefits of last-minute demand before the tax hike has probably run their course, external demand may need to pick up some of the slack. "While capital spending is likely to underpin economic activity ahead, external demand, particularly China, poses a risk to the Japanese economy," said Naoki Iizuka, economist at Citigroup Global Markets Japan. In China, worries of a sharp slowdown there have stoked speculation Beijing will launch stimulus measures to bolster growth. BOJ tankan eyed Analysts are also looking out for the Bank of Japan's key tankan survey due on Tuesday, which may offer clues on any impacts of the sales tax hike on business sentiment in the three months to March and their outlook in the following quarter. Sentiment at big firms are expected to improve slightly in the three months to March for a fifth straight quarter but it is seen sliding in the following quarter after the tax hike. Weaker-than-expected tankan readings could heighten market expectations for the BOJ to embark on further monetary stimulus in the coming months. Investors are already expecting the central bank to ease policy further by this summer to make good on its pledge of meeting a 2 percent inflation target by around early 2015. Analysts doubt the inflation target can be met without further stimulus, with core consumer inflation struggling to accelerate from the current annual gain of above 1 percent driven mostly by high energy prices on a weak yen. UPBEAT ASSESSMENT The METI data showed auto makers, manufacturers of mobile phones, personal computers and heavy machinery led declines in industrial production. The METI stuck to its assessment that industrial output is picking up, and in a press briefing noted that the weakness in February was largely a one-off event due to adverse weather that disrupted factory operations and distribution networks. The level of production remains high above last year's peak of 100.1 hit in December and it is expected to maintain the current levels in the coming months, they said. A survey of manufacturing released earlier in the day also showed weather-related impacts. The Markit/JMMA Japan Manufacturing Purchasing Managers Index (PMI) fell to a seasonally adjusted 53.9 in March from 55.5 in February, keeping above the 50 threshold that separates expansion from contraction for a 13th consecutive month. Analysts believe factory output is maintaining a rising trend, underpinned by firm domestic conditions and a pickup in external demand. Still, while a consumption-boost is expected to support growth in the current quarter, the economy is seen contracting in the April-June quarter as consumer spending dips after the sales tax hike. Many analysts are counting on the BOJ to keep the economy on an even keel, and an expected rebound in the third quarter looks increasingly dependent on the central bank's largesse. "I'm closely watching how production will fare in April and May after the sales tax hike. Bleak figures would boost expectations for further monetary stimulus by the Bank of Japan," Citigroup's Iizuka said. (Reporting by Tetsushi Kajimoto; Editing by Shri Navaratnam)