By Takahiko Wada and Leika Kihara
TOKYO (Reuters) -Core inflation in Japan's capital slowed in September for the third straight month mainly on falling fuel costs, data showed on Friday, suggesting that cost-push pressures are starting to peak in a relief for the fragile economic recovery.
But separate data showed factory output was flat in August, a sign companies were feeling the pain from soft global demand and weak signs in China's economy.
A government survey released on Friday also showed consumer sentiment soured in September, as many households have yet to see wages increase enough to offset rising living costs.
The batch of data underscores the challenge the Bank of Japan faces in determining how soon it could phase out its massive stimulus, without choking off growth, analysts say.
"Even though inflation is now moderating, it is doing so less quickly than the Bank of Japan had anticipated. Accordingly, the Board will need to revise up their inflation forecast for the current fiscal year further at their next meeting in October," said Marcel Thieliant, head of Asia-Pacific at Capital Economics.
"Our view is that the Bank will use the current window of opportunity to abandon negative interest rates and have pencilled in a rate hike in January next year."
The Tokyo core consumer price index (CPI), which excludes volatile fresh food but includes fuel costs, rose 2.5% in September from a year earlier, against a median market forecast for a 2.6% gain.
It slowed from a 2.8% increase in August but exceeded the Bank of Japan's 2% target for the 16th straight month.
An index that strips away both fresh food and fuel costs, which is closely watched by the BOJ as a better gauge of broad price trends, rose 3.8% in September from a year earlier after a 4.0% gain in August, the data showed.
A spike in global commodity prices last year drove many Japanese companies to shed their aversion to price hikes and pass on higher costs to households, keeping inflation above the BOJ's target for longer than policymakers initially expected.
The inflation overshoot led the BOJ to make modest tweaks to its bond yield control policy last month, a move investors saw as a shift away from decades of ultra-loose monetary policy.
But Governor Kazuo Ueda has ruled out the chance of an early exit from ultra-loose policy, saying that it needs to wait until wages rise enough to keep inflation sustainably around 2%.
Japan's economy expanded an annualised 4.8% in April-June as robust exports offset weaknesses in consumption. But analysts expect a mild contraction in the July-September quarter as sluggish global demand weighs on exports.
Underscoring the fragile nature of the export-reliant economy, factory output weakened in August as automobile production fell due largely to plant shutdowns at Toyota Motor (NYSE:TM) Corp.
Manufacturers surveyed by the government expect output to rise 5.8% in September and increase 3.8% in October, though overseas economic uncertainties cloud the outlook, said an official who briefed reporters on the output data.