Japan Economy Holds Steady as Tax Hike Looms

Japan's recovery is holding steady ahead of a looming sales tax hike, economic indicators showed Friday, though weakness in wages and spending suggest it remains vulnerable to a reversal.

The consumer price index rose 1.3 percent in January and factory production also climbed.

Past experience suggests Japan will see a big plunge in demand after the 3 percentage point tax hike to 8 percent on April 1, said economist Masamichi Adachi of JP Morgan in Tokyo.

"It is a very difficult time to gauge the underlying strength of the economy," he said.

As manufacturers and retailers raise prices to compensate for higher costs they are passing them on to consumers, who already appear to be tightening their belts to compensate.

Japanese awoke Friday to front-page reports of plans for hikes in the prices paid for vending machine soft drinks and plans for further increases in gas and electricity rates.

Contrary to earlier expectations, manufacturers are forecasting that factory output will fall in March, following a 4 percent increase in January to about the level it was at before a massive earthquake and tsunami hit northeastern Japan in March 2011, the Ministry of Economy, Trade and Industry reported.

Japan's financial industry and banks are relatively sound, compared with the 1990s. Its companies have much less debt and there is no reason to expect a major regional crisis similar to the one that slammed the economy in 1997, plunging the economy into recession. By coincidence, that period of economic trauma followed a tax hike in Japan.

The government and central bank have unleashed a flood of monetary and fiscal stimulus aimed at breaking Japan free from a long spell of deflation, or falling prices, that is thought to discourage investment and spending.

But the central bank needs to ensure financial markets remain stable and Prime Minister Shinzo Abe needs to deliver on promises for reforms to help make the economy more competitive, Adachi said.

"Confidence matters a lot for Abenomics," he said. "More stimulus is necessary and more structural change, so people will believe things will change."

In a rare cautionary remark Thursday, a Bank of Japan vice governor, Takehori Sato, emphasized that the central bank must focus on a full and sustainable recovery, rather than just achieving the government's inflation target of 2 percent.

"What the price stability target aims to achieve after all is not simply a rise in prices. Rather, it aims to achieve a situation in which a rise in prices is accompanied by a rise in wages, coupled with an improvement in the overall economy," Sato said.

Given the expected impact of the tax hike, "we have to avoid leaving an impression that the Bank has been solely pursuing a pick-up in prices without due attention to the economy."

March is labor negotiation season in Japan, and some of the biggest companies have indicated they are open to raising base wages, rather than just bonuses or other payments, for the first time in years.

But such increases are likely to be modest at less than the equivalent of $100 a month and will affect only a fraction of the work force.

For most workers, real incomes will continue to fall as prices rise.

January's 1.3 percent rise in core inflation marked the eighth straight month of price increases and matched the increase in December. Excluding both food and energy, prices rose 0.7 percent, also on a par with the month before.

The "'core' and 'core-core' measures have started to level off at levels well short of the target," Capital Economics said in a commentary. It said that suggests the Bank of Japan needs to do more to hit its eventual inflation target of 2 percent.

In other data:

— The jobless rate remained steady at 3.7 percent, with 104 job offers for every 100 job seekers. Companies generally have stepped up use of overtime and hiring of part-time workers to handle higher demand.

— Retail sales rose 1.4 percent from a month earlier after falling in December.

— Household incomes fell 0.6 percent, while seasonally adjusted household spending fell 1.6 percent from the month before.