Weak spending overshadows Japan's surprise first quarter economic expansion

© Reuters. FILE PHOTO: Man stands in front of shopping mall nearby Bank of Japan building in Tokyo

By Tetsushi Kajimoto and Leika Kihara

TOKYO (Reuters) - Japan's economic growth unexpectedly accelerated in January- March, driven by net contributions from exports and defying forecasts for a contraction in the world's third-largest economy.

However, the surprise expansion was mostly caused by imports declining faster than exports, likely reflecting weak domestic demand, a point of concern for policymakers with a planned sales tax hike scheduled to take effect in October.

Underscoring this challenge were private consumption and capital expenditure readings, which both fell in the first quarter, while exports suffered the biggest fall since 2015.

Japan's economy grew at an annualized 2.1% in the first quarter, gross domestic product (GDP) data showed on Monday, beating market expectations for a 0.2% contraction. It followed a revised 1.6% expansion in October-December.

The soft patches behind the headline GDP number could keep alive speculation that Prime Minister Shinzo Abe may postpone a twice-delayed increase in the sales tax in October.

"All of the most important components of GDP are negative," said Hiroaki Muto, chief economist at Tokai Tokyo Research Center.

"The economy has already peaked out, so we are likely to have a mild recession," he said. "No one would object to delaying the sales tax hike."

The headline GDP expansion was caused largely by a 4.6% slump in imports, the biggest drop in a decade and more than a 2.4% fall in exports.

As imports fell more than exports, net exports - or shipments minus imports - added 0.4 percentage point to GDP growth, the data showed.

Private consumption slid 0.1% and capital expenditure dropped 0.3%, casting doubt on policymakers' view that solid domestic demand will offset the pain from slowing exports.

There have been growing calls from some former policymakers to delay the sales tax hike in the face of worsening domestic and external conditions.

However, Economy Minister Toshimitsu Motegi put a brave face on Monday, saying that there was no change to the government's plan to raise the sales tax to 10% from 8% in October.

"There's no change to our view that the fundamentals supporting domestic demand remain solid," Motegi told reporters after the data's release.

But some analysts warn that Japan's economy will continue to face headwinds that could dent growth in coming quarters.

"Consumer spending is likely to remain weak, because wages are not rising that much," said Kentaro Arita, senior economist at Mizuho Research Institute.

"In the second quarter, GDP could be zero or slightly negative because exports will remain weak. This, combined with weakening capital expenditure, means there is a risk of a recession."

The GDP data comes as the government's coincident economic indicator flagged the possibility Japan may be in a recession as exports and factory output were hit by China's slowdown and the Sino-U.S. trade war.