Japan Q2 economy contracts annualised 6.8% as tax hike bites

TOKYO (Reuters) - Japan suffered its biggest economic contraction since the devastating March 2011 earthquake in the April-June quarter as a sales tax hike took a heavy toll on household spending, stoking fears that any rebound may be too modest to sustain a solid recovery.

While the soft data is unlikely to shake the Bank of Japan's conviction that the economy can ride out the tax hike impact, it could add pressure on the bank for further monetary easing if weakness in exports and consumption is prolonged.

The world's third-largest economy shrank an annualised 6.8 per cent in the second quarter, less than a median market forecast for a 7.1 per cent drop and following a 6.1 per cent increase in January-March as consumers spent heavily to avoid the sales tax increase, Cabinet Office data showed on Wednesday.

The government took a relaxed view of the data, with Economics Minister Akira Amari saying in a statement: "Looking at monthly data during April-June, sales of electronics goods and those at department stores are picking up after falling sharply in April.

"The job market is also improving steadily. Taking these into account, Japan's economy continues to recover moderately as a trend and the effect of the sales tax hike is subsiding."

The second quarter contraction was the biggest decline since the first quarter of 2011, when the devastating earthquake and tsunami struck in March.

On a quarter-to-quarter basis, Japan's economy shrank 1.7 per cent in the second quarter, less than a median market forecast for a 1.8 per cent fall, the data showed.

"The economy will rebound to annualised growth around 5 per cent in July-September" due to strong summer bonuses and public works spending, said Takeshi Minami, chief economist at Norinchukin Research Institute.

"The BOJ remains focused on prices and it could ease again in October when it reviews its economic outlook, with prices likely undershooting its projections."

Private consumption, which makes up about 60 per cent of the economy, took a hit from the sales tax hike in April to fall 5 per cent in the quarter, more than a median market forecast for a 4.3 per cent drop.

Exports, a main driver of the economy, showed signs of a recovery from recent weakness. External demand added 1.1 percentage points to economic growth, after shaving 0.2 percentage point off growth in the first quarter.

The BOJ has kept monetary policy steady since deploying an intense burst of stimulus in April last year, when it pledged to double base money via aggressive asset purchases to accelerate inflation to 2 per cent in roughly two years.

BOJ Governor Haruhiko Kuroda has repeatedly said he wouldn't be surprised or fazed to see a contraction in April-June economic activity, which would largely be in reaction to a surge in demand ahead of the tax hike. He has argued that growth is set to rebound in the third quarter as tightening labour markets boost wages and support household spending.

The central bank thus sees no need to expand monetary stimulus any time soon. But some board members have offered a more cautious view on the outlook than Kuroda, warning that the rebound in July-September could be softer than expected as a much hoped-for pick-up in exports has been delayed.

Exports unexpectedly fell in June for a second straight month and output plunged at the fastest pace since the March 2011 earthquake, forcing the BOJ to revise down its assessments on exports and output last week.