By Leika Kihara and Stanley White TOKYO (Reuters) - 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.
"Production and consumption are both stagnating, and the economy is clearly undershooting projections of the government and the BOJ," said Taro Saito, senior economist at NLI Research Institute.
"The BOJ will be forced to cut its economic view sooner or later, although it is unlikely to move anytime soon as it argues for rising inflation."
Household spending fell 5.9 percent 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 percent in July, much less than a 1.0 percent increase projected in a Reuters poll, data by the Ministry of Economy, Industry and Trade showed. That was a tepid rebound from a 3.4 percent fall in June, the fastest drop since the March 2011 earthquake.
Manufacturers expect output to rise 1.3 percent in August and 3.5 percent 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 percent.
"The BOJ says now that output is rising as a trend, but I think it's hard to continue saying so with today's data as output has been falling after peaking in January," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute.
"The economy is still recovering, so the BOJ will probably hold off on easing this year. But if data continues to remain weak, it might be forced into action," he said.
ROSY VIEW IN DOUBT
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 percent from 8 percent.
Analysts generally expect 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.
Economics Minister Akira Amari told reporters after the data there was no need to be so pessimistic about household spending, while Finance Minister Taro Aso said that the impact of April's sales tax hike on the economy is gradually easing but it needs close monitoring from now on.
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 percent inflation target.
The jobless rate rose to 3.8 percent in July from June's 3.7 percent 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 percent in the year to July, matching a median market forecast. When excluding the effect of the April tax hike, it stood at 1.3 percent, still distant from the 2 percent inflation target the Bank of Japan pledged to meet sometime next year.
Japan's economy shrank at an annualized 6.8 percent in the second quarter from the previous three months, more than erasing the 6.1 percent 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.
(Additional reporting by Tetsushi Kajimoto; Editing by Eric Meijer & Shri Navaratnam)