Japanese household spending fell much more than expected and factory output remained weak in July after plunging in June, government data showed, suggesting that soft exports and a sales tax hike in April may drag on the economy longer than expected.

While the Bank of Japan is in no mood to expand monetary stimulus any time soon, the data undermines the BOJ's rosy economic forecasts and will keep it under pressure to act if the economy fails to gather momentum, analysts say.

The soft readings may also fuel speculation that the government could delay a second sales tax increase scheduled for next year, or try to compile another fiscal stimulus package, which would further worsen Japan’s debt burden.

Household spending fell 5.9 per cent in July from a year earlier, nearly double the drop forecast in a Reuters poll, as the higher levy and bad weather kept consumers at home instead of going out shopping.

Weak exports left companies with a huge pile of inventories, forcing them to continue cutting back on factory output, separate data showed.

Industrial output rose 0.2 per cent in July, data by the Ministry of Economy, Industry and Trade showed. That was a tepid rebound from a 3.4 per cent fall in June, the fastest drop since the March 2011 earthquake.

Manufacturers expect output to rise 1.3 per cent in August and 3.5 per cent in September. But a ministry official told a briefing there was uncertainty on whether production will rise as companies had continued to overestimate their outlook plans.

Most industries, except for makers of industrial machinery, cut output in July and an index gauging inventory hit the highest level since November 2012, underscoring the view the post-tax slump in consumption was bigger than expected.

Analysts expect factory output in July-September to fall from the previous quarter, suggesting that any rebound in the economy will be modest and casting doubt on the BOJ’s view the recovery will be strong enough to lift inflation to 2 per cent.

The BOJ is likely to keep monetary policy steady and stick to its view that the economy is recovering moderately when it meets for a rate review next week, though pessimists in the board may argue for more downbeat language in describing consumption and output, given Friday’s weak data.

The soft data also complicates prime minister Shinzo Abe’s decision on whether to proceed with the next proposed sales tax hike in October 2015, to 10 per cent from 8 per cent.

Analysts generally expect Mr Abe to approve another tax hike in December, but that decision promises to be politically divisive, coming just as the government hammers out details of a promised corporate tax cut.

Despite weak signs in the economy, the BOJ is optimistic that a tightening job market will lead to higher wages and more income for households to spend, thereby keeping Japan on track to meet its 2 per cent inflation target.

The jobless rate rose to 3.8 per cent in July from June’s 3.7 per cent but the jobs-to-applicants ratio remained at a 22-year high of 1.10, a good omen for the BOJ.

Data due next week on employee wages and the manufacturing purchasing managers index (PMI) will offer further clues to whether domestic demand will weaken further or gain momentum.

Separate data showed core consumer inflation, which excludes volatile prices of fresh foods but includes oil products, hit 3.3 per cent in the year to July, matching a median market forecast. When excluding the effect of the April tax hike, it stood at 1.3 per cent, still distant from the 2 per cent inflation target the Bank of Japan pledged to meet sometime next year.

Japan’s economy shrank at an annualised 6.8 per cent in the second quarter from the previous three months, more than erasing the 6.1 per cent first-quarter surge in the run-up to the sales tax hike.

Many analysts agree with the BOJ that growth will rebound in the current quarter, though some warn that the recovery may falter later this year if the tax-hike pain is prolonged and exports fail to emerge from the doldrums.

Reuters