Updated: 08/13/2014 12:46 | By Agence France-Presse

Japan's economy shrinks after sales tax hike

Japan's economy shrank in the latest quarter as a sales tax hike slammed the brakes on spending by the nation's households and companies, the first significant pullback since late 2012, government data showed Wednesday.

Japan's economy shrinks after sales tax hike

Employees of Toyota Motor's subsidiary Toyota Motor Kyushu mount an engine into the body of a Lexus NX, on an assembly line at the Miyata Plant in Fukuoka Prefecture, on August 8, 2014 - by Toru Yamanaka

The 1.7 percent contraction in gross domestic product gave the clearest picture yet on the impact of the levy rise, and underscored Tokyo's challenge in pressing on with a bid to resuscitate an economy long plagued by deflation and laggard growth.

The data were also likely to raise questions about whether Tokyo would usher in another tax hike next year, as it moves to tame the country's massive national debt.

While the April-June figures -- which translated into a 6.8 percent contraction on an annualised basis -- were slightly better than market expectations, they appeared at odds with the government and Bank of Japan's take that the impact on the world's number-three economy had been minimal.

With the exception of flat growth in the last quarter of 2013, the Wednesday data marked the first quarterly contraction in nearly two years.

The economy had been on the upswing as Prime Minister Shinzo Abe's growth blitz, dubbed Abenomics, helped sharply weaken the yen, giving a lift to exporters' profitability and driving a stock market rally last year.

A huge monetary easing campaign by the Bank of Japan (BoJ) was a cornerstone of the programme.

But economists warned that the strong growth would take a hit as Tokyo hiked its consumption tax to 8.0 percent from 5.0 percent -- the first levy rise in 17 years.

Millions of shoppers launched a last-minute buying binge on everything from cars and washing machines to televisions and alcohol, before the increase on April 1.

Demand fell sharply after prices went up, with the fresh data showing a 5.2 percent drop in household spending, a 10.3 percent plunge in real-estate investment, and a 2.5 percent fall in capital spending.

- Bank of Japan stimulus -

Last week, the central bank warned over a worsening export and factory output picture, but it held fire on launching more stimulus, saying the economy was recovering.

The latest data were likely to add to speculation that a pullback in the economy would force the BoJ's hand on more monetary easing.

Bank governor Haruhiko Kuroda has repeatedly said he was ready to pull the trigger on more stimulus -- similar to the Federal Reserve's quantitative easing -- but last week gave little indication such a move was imminent.

"The BoJ is likely to change its economic outlook downward -- and the market expectation for further monetary accommodation is likely to grow further," said Takahiro Sekido, a strategist at the Bank of Tokyo-Mitsubishi UFJ.

It remains unclear if Abe will follow through on a plan to raise taxes again to 10 percent next year in light of the growth data, and as he faces criticism over the pace of his efforts to shake up the highly regulated and protected economy.

The country's last sales tax rise in 1997 foreshadowed a drop into years of deflation and tepid growth. 

But many economists have noted that the circumstances were different, with the earlier rise coming in the midst of the Asian financial crisis.

"The contraction was within market expectations, but the decline in private consumption was bigger than we thought," Yoko Takeda, chief economist with Mitsubishi Research Institute, told AFP.

"But we still see the Japanese economy as being on course for a gradual recovery."

She added that the second-quarter figures were an "exception" due to the tax hike.

"It is more important to see the July-September quarter," Takeda said.

"That will be the key to predicting the future of the economy, and crucial for making a decision about raising the sales tax again."

-- Dow Jones Newswires contributed to this report --

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