An employee works on a glass sheet for a door at a glass factory in Tokyo. Japan’s factory output fell 2.3% in February, the first decline in three months.

AFP/Tokyo

Japanese factory output contracted in February, data showed yesterday, a surprise decline that highlighted the uneven economic recovery in the world’s number three economy as consumers brace for a sales tax hike.

The 2.3% fall in output from January – the first decline in three months – is likely to aggravate concerns about the potential impact of the increased levy, which takes effect today.

There are fears that the tax rise to 8% from 5% – seen as crucial to paying down Japan’s huge national debt – will weigh on consumer spending and derail a budding recovery.

The last time Japan brought in a higher levy in 1997, it was followed by years of deflation and tepid economic growth.

Prime Minister Shinzo Abe faces a tricky balancing act as he tries to nudge the economy out of a cycle of falling prices and lacklustre growth with a growth blitz dubbed Abenomics.

Falling production of large passenger cars and auto parts led the decline in February’s factory output, underscoring how exports and domestic spending remain wobbly.

A producers’ survey released with the government data show manufacturers expect a rise in March industrial production followed by a decline in April as the effects of the tax hike become clearer.

“Industrial production continues to show an upward movement,” said the economy, trade and industry ministry.  However, the weaker-than-expected data will mean a renewed focus on the Bank of Japan’s widely watched Tankan quarterly business confidence survey, set to be released today.

Adding to concerns over the economy, the Markit/JMMA purchasing managers index, published Monday, fell in March from a month earlier, to 53.9 from 55.5. A reading of 50 or above indicates growth.

“Output continued to expand (in March), which companies attributed to a hike in demand before the increase in the sales tax,” Markit said.

“However, the expansion in output was slower than February and the weakest seen in six months. Panellists partly blamed the weakening of the expansion of output on factories being damaged by heavy snow.”

Poor winter weather hammered parts of Japan, as a deep freeze in North America was also blamed for weaker activity in the US.

Last week, more upbeat figures showed Tokyo’s bid to stoke lasting inflation in a country plagued by years of falling prices was gathering steam, while unemployment fell to a more than six-year low.

But the stronger inflation reading was largely driven by rising post-Fukushima energy import costs, rather than prices going up on the back of strong, across-the-board consumer demand.

A key worry is that Japan’s last tax rise foreshadowed a cycle of falling prices although other factors, including the Asian financial crisis, were also blamed.

“It will be interesting to see whether output in the manufacturing industry will continue to grow as fast after the increase in the sales tax is implemented,” said Amy Brownbill, a Markit economist.  Last time “the overall fall in demand contributed to a prolonged downturn, and there will be concern of something similar happening again”. Meanwhile, another data showed Japan’s core consumer prices rose for a ninth straight month in February from a year earlier and labour demand improved - further evidence the economy is making headway against years of deflation and stagnation.

Ministry of finance data showed household spending and retail sales weakened in February as snowstorms across Japan kept many consumers at home, but there are already signs that sales are accelerating this month as shoppers rush to beat a sales tax hike on April 1.

The dip in consumer spending may be disappointing to some, but continued tightness in the labour market could bolster expectations that the economy can weather the sales tax rise to 8% from 5%, and rebound after a temporary slump in the April-June quarter.

“The gradual increase in prices is consistent with a narrowing in the negative output gap,” said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management. (A negative output gap shows the economy is performing below full capacity.)

“The employment situation will also continue to put some mild upward pressure on prices. Consumer spending came in weak, but it will rebound next month.”

The 1.3% annual gain in the core consumer price index, which includes oil products but excludes volatile fresh food prices, matched the median estimate in a Reuters poll. The gain followed a 1.3% rise in January and December, which was the quickest since the 1.9% seen in October 2008. The narrower inflation index, which excludes food and energy prices and is similar to the core index used in the United States, rose 0.8% in the year to February. That matched a high last hit in April 1998 - a sign Japan is pulling further away from deflation.

Japan’s consumer inflation has accelerated in the past several months since turning positive last June, with the Bank of Japan’s aggressive monetary easing driving down the yen. Analysts believe inflation may slow in coming months as the weak yen’s tendency to drive up import prices fades away.

Given this trend, many economists doubt that the central bank can achieve its aim of hitting a 2% inflation target in about a year, due to the persistent output gap and companies’ reluctance to significantly increase capital spending and raise wages.

Analysts polled by Reuters expect the BoJ to ease policy further by the summer to stimulate growth and accelerate inflation.

Analysts expect the economy to contract in the April-June quarter as consumer spending dips after the sales tax hike takes effect, before rebounding in July-September.

Separate government data showed Japan’s jobless rate fell to 3.6% in February, the lowest in more than six years.

The jobs-to-applicants ratio edged up to 1.05, meaning available jobs outnumber jobseekers. The ratio matched the median estimate and hit its highest since July 2007, underscoring the strength of the job market.

Retail sales grew an annual 3.6% in February, exceeding the median estimate for a 3.2% annual gain, but below January’s 4.4% as a series of snowstorms hit consumer spending.

Household spending tumbled 2.5% after inflation in the year to February, versus the median estimate for a 0.1% increase, another sign of bad weather disrupting economic activity in February.