Japan suffers worst economic slump since 2011 'quake

Japan's economy likely contracted at a 7.1 percent annual rate from the previous three months as a sales-tax hike battered consumption. The poor economic performance for Japan may increase pressure on Prime Minister Shinzo Abe's administration to step up stimulus measures. 

Japan's economy likely shrank sharply in the second quarter, which would be bad news for Prime Minister Shinzo Abe's growth policies, but it could raise market expectations of further stimulus.

Data due at 8:50 a.m. Wednesday Japan time (2350 GMT on Tuesday) will show gross domestic product contracted at a 7.1 percent annual rate from the previous three months as a sales-tax hike battered consumption, economists forecast in a Reuters poll.

The deepest slide since the global financial crisis and the first in nearly two years could call into question Abe's program of ending 15 years of deflation and tepid growth with massive monetary easing, hefty government spending and structural reforms.

"It's going to be hard for the economy to regain momentum, given weak exports and a decline in real income, which weighs on private consumption," said Takeshi Minami, chief economist at the Norinchukin Research Institute.

"The economy will rebound in July-September but growth is likely to stay modest in October-December."

Markets are poised for a downside surprise, and investors in the near term could be cheered by a bad result if they think it puts pressure on the Bank of Japan to increase its asset purchases, or on Abe not to raise the sales tax again, market participants say.

"If GDP undershoots, the BOJ will likely be forced to change its assessment of consumption," said Naoki Murakami, market strategist at Alliance Bernstein Japan. "Even if this doesn't lead to a debate about immediate further easing, markets may seize on it in anticipation."

ECONOMISTS DOWNGRADE FORECASTS

The expected pullback from the tax hike - following a 6.7 percent first-quarter surge ahead of the new levy - comes even as Japanese companies have finally been able to start passing on higher labor and materials costs to consumers and other businesses.

Economists had been penciling in a roughly 5 percent April-June drop until recent data showed the weakest factory output since 2011 and a second surprise monthly drop in exports, confirming that the weakness in the world's third-biggest economy is widespread.

One quarter's GDP is unlikely to alter the policy debate alone, unless it is so bad that it derails the BOJ's baseline recovery scenario, economists say.

And BOJ Governor Haruhiko Kuroda has been relentlessly upbeat about Japan's outlook, even as private economists have become gloomier.

"Japan's economy is likely to continue recovering moderately with the effect (of the tax increase) seen gradually subsiding," Kuroda said on Friday, even as the central bank cut its assessment of exports and output.

As for the tax hike, Abe's government has said he will scrutinize July-September GDP and other data to make his decision around year-end on whether to proceed with a planned rise in the sales tax to 10 percent from eight percent.

Wednesday's forecast contraction is almost twice as steep as the 3.7 percent drop from 1997, the last time the sales tax was raised - a move that preceded a steep recession and ended the political career of Ryutaro Hashimoto, the premier who pushed through the tax increase in a bid to curb Japan's spiraling government debt.

But policymakers and many economists say a simple comparison with the previous hike is not easy, because that recession was greatly compounded by the Asian financial crisis. (Additional reporting and writing by William Mallard; Editing by Mike Collett-White)