By Tetsushi Kajimoto
TOKYO (Reuters) - Japan's industrial output rose at the fastest pace in eight months in September, but analysts say the economy would need to show more signs of a durable recovery before the government can confidently proceed with plans for a second sales tax hike.
The 2.7 percent rise in factory output topped economists' median estimate of a 2.2 percent gain, led by demand for cars and smartphones, the trade ministry's data showed, following a 1.9 percent drop in August.
The upbeat report comes on the heels of government data on Tuesday showing retail sales rose for the third straight month in September - evidence the economy may be finally gaining traction after slumping on the back of an April sales tax hike .
Still, doubts remain whether Prime Minister Shinzo Abe could proceed with a second increase in the sales tax planned for October 2015, with markets continuing to speculate the Bank of Japan or the government would offer additional stimulus to safeguard a fragile recovery.
"The outlook is not so bright. Final domestic demand is unlikely to rebound as it takes time for private consumption to recover given deterioration in job-related indicators," said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo.
"Prospects for external demand have not improved either. China's domestic demand is slowing and U.S. ISM (manufacturing activity index) suggests that global output is likely to slow in January-March."
Many analysts hope Abe will decide in December to proceed with the planned tax hike next year, but expect such a decision to be accompanied by plans for fresh stimulus measures. Markets fear that dithering over the tax plan could undermine confidence in Japan's public finances and hit the economy hard.
The BOJ, however, is in mood to ease policy again anytime soon.
At its policy review on Friday the central bank is expected to slash its growth projections but stick to its rosy view that the economy is on track to meet a 2 percent inflation target sometime next year - a prediction seen as unrealistic by many analysts.
The April sales tax hike to 8 percent from 5 percent drove the world's third-biggest economy into its deepest quarterly slump since the 2009 global financial crisis in the second quarter. Since then, a run of weak data has cast doubt about Abe's plans for the second tax increase, seen as a key in government efforts to contain Japan's heavy debt load.
SHAKY GLOBAL ECONOMY
Factory activity has been languishing since the April tax hike, which dampened demand for cars and housing construction, leaving companies saddled with a pile of inventories of unsold goods.
Cooling global growth may also weigh on external demand and factory output, particularly with a slowdown in China and the threat of recession in Europe complicating Abe's strategy to reflate the economy and quash deflation.
Highlighting the growing global risks, Sweden's central bank cut interest rates more than expected to zero on Tuesday to ward off prolonged deflation risk.
The uncertainty was reflected in Japanese manufacturers' outlook, with the ministry's survey showing they expected output to fall 0.1 percent in October but increase 1.0 percent in November.
"Companies are entering a stage where it needs to adjust inventories and production. We'll closely watch how long this adjustment will last," said a trade ministry official. The ministry notched up its view of industrial output, saying it is "seesawing", from the previous description that it was weakening.
Other key indicators for September due this week are also likely to show falling household spending, slowing consumer inflation and a rising jobless rate.
The government plans to raise the sales tax to 10 percent in October 2015 in a bid to fund bulging welfare costs and rein in mammoth public debt that at twice the size of the economy is by far the worst in the industrial world.
Analysts polled by Reuters forecast the economy would grow an annualised 2.9 percent in the third quarter, after an annualised 7.1 percent slump in the prior three months.
Some analysts believe the economy may have enough momentum to absorb the second sales tax increase, though concede the decision may not be straight forward.
"I think economic growth in the third quarter will be strong enough to allow for another sales tax hike, but it all depends on how confident the politicians are about the economy," said Norio Miyagawa, senior economist at Mizuho Securities Research & Consulting Co.
(Additional reporting by Stanley White; Editing by Shri Navaratnam)