Japan’s factory output rose in January at the fastest pace in more than two years and core inflation hovered at five-year highs, suggesting the economy has enough momentum to withstand an expected hit from a sales tax hike scheduled for April.

Other data were equally upbeat, with labour demand improving and household spending rising in a sign the world’s third-biggest economy is on course to shaking off two decades of stagnation even as it steers through some speed bumps.

Domestic consumption is seen supporting activity as shoppers brought forward purchases, but the recent debate in markets has centred around an expected chill in demand after the tax hike and the risks that it may take the wind out of the government’s growth strategy.

"I'm not that confident about the economy after the sales tax hike," said Norio Miyagawa, senior economist at Mizuho Securities Research & Consulting Co.

“Consumer spending will not be as strong as it is now. There are a lot of uncertainties about exports. Once the BOJ realises that consumer prices are not accelerating, it will start to debate other measures.”

After decades of sluggish growth, the economy shifted into higher gear over the last year after prime minister Shinzo Abe launched an aggressive cocktail of monetary and fiscal stimulus policies.

However, markets are starting to worry about the durability of the rebound, especially as exports have failed to substantially perk up while business investment and wages growth have trailed expectations.

The planned sales tax hike to 8 per cent from 5 per cent has added to the uncertainty, although policy makers have said that they are prepared to look past a temporary dip in activity.

Bank of Japan board members have voiced confidence in recent weeks that the economy is on track for a moderate recovery, suggesting that they see no immediate need for further easing.

Japan’s industrial output rose 4.0 per cent in January to levels last seen before the October 2008 Lehman collapse, Indicating that robust domestic demand is underpinning the economy as consumers rush to beat the national sales tax hike.

The rise beat the median forecast for a 3.0 per cent as firms ramp up output of cars and consumer appliances. It marked the fastest gain since output rose 4.2 per cent in June 2011 after a plunge caused by the March earthquake and tsunami.

Manufacturers surveyed by the Ministry of Economy, Trade and Industry expect output to rise 1.3 per cent in February but decrease 3.2 per cent in March, trade ministry data showed.

“Effects of the last-minute demand is clearly emerging. March forecast suggests that firms may be front-loading output earlier than previously thought,” said a ministry official.

Some analysts blame the last sale tax hike in April 1997 for exacerbating a downturn in the economy when it was also hit by the Asian financial crisis.

A Reuters poll last week showed the BOJ is expected to ease policy further by this summer to help boost the economy as the effects from Mr Abe’s stimulus strategy begin to wane.

Analysts expect the economy to contract in the April-June quarter as consumer spending falls sharply after the sales tax hike takes effect, before rebounding in July-September.

Inflation

Japan’s core consumer price index (CPI), which excludes fresh food prices but includes oil products, rose 1.3 per cent year-on-year in January, ahead of the median estimate for a 1.2 pe rcent annual increase.

That matched a 1.3 per cent annual increase in December - the fastest in more than five years.

The central bank maintained its massive monetary stimulus at last week’s policy meeting, aiming to meet a 2 per cent price goal around early 2015, which is seen by many analysts as overly ambitious.

The biggest risk for policymakers is a rapid deterioration in business and consumer confidence, especially if data after the tax hike shows the economy slowing more sharply than expected.

However, the BOJ has said it will proactively adjust policy to head off major risks to the economy.

"If risks force us to change our projections toward meeting our 2 per cent inflation target, we'll make necessary policy adjustments," BOJ Deputy Governor Hiroshi Nakaso told parliament this week.

Still, most analysts expect that inflation will struggle to pick up pace in the coming months as the effects of a weak yen on imported goods taper off. There are also worries private consumption could lose steam after the sales tax is raised.

Meanwhile, external risks are also a worry, especially as it could dent Japan’s exports. Renewed stress in emerging markets last month sent Japanese stocks down on concern it could hurt the economy.

Japan’s jobless rate was unchanged at a six-year low of 3.7 per cent in January.

The jobs-to-applicants ratio edged up to 1.04, meaning more than one job is available per job seeker. The ratio matched the median estimate and hit the highest since August 2007, underlying the strength of the job market.

Household spending rose 1.1 per cent in the year to January, blowing past the median estimate for a 0.2 per cent increase.

That marked a fifth straight month of annual gains and an acceleration from a 0.7 per cent annual increase in December as consumers spent more on clothes, cars and domestic travel.

Reuters