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Japan economy shrinks as tax hike hammers spending in worst contraction since tsunami disaster

A pigeon sits as a shoeshine prepares to work in Tokyo, Wednesday, Aug. 13, 2014. The Japanese economy shrank at an annual pace of 6.8 percent in the second quarter after spending got slammed by a sales tax hike that kicked in from April, government figures showed Wednesday. (AP Photo/Shizuo Kambayashi)

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A pigeon sits as a shoeshine prepares to work in Tokyo, Wednesday, Aug. 13, 2014. The Japanese economy shrank at an annual pace of 6.8 percent in the second quarter after spending got slammed by a sales tax hike that kicked in from April, government figures showed Wednesday. (AP Photo/Shizuo Kambayashi)

TOKYO - The Japanese economy shrank at an annual pace of 6.8 per cent in the second quarter after spending got slammed by a sales tax hike that kicked in from April, government figures showed Wednesday.

Japan's gross domestic product, or the total output of goods and services, also contracted 1.7 per cent during the April-June period from the previous quarter.

The decline in GDP was the worst since the March 2011 tsunami and quake disaster in northeastern Japan. In the first quarter of 2011, Japan's economy shrank at an annual rate of 6.9 per cent.

The weak figures were expected as consumers and businesses had front-loaded spending in the first quarter to beat the April 1 increase in sales tax. Economists expect spending to pick up again in coming months.

The results were a stark contrast to the annual 6.1 per cent growth in the first quarter of the year, which reflected the buying rush to beat the tax rise.

The government, under Prime Minister Shinzo Abe and his "Abenomics" strategy, has been trying to pull world's third-biggest economy out of two decades of stagnation by expanding the money supply, freeing up regulations and encouraging the yen to fall, a move that helps exporters such as Toyota Motor Corp. and camera maker Canon Inc.

But the government is also concerned about ballooning public debt and raised the consumption tax to 8 per cent from 5 per cent to shore up its coffers.

Previous administrations have been nervous about raising taxes for fear the economy will slide into a recession. The Japanese economy has been eking out growth or at least staying flat in recent quarters, thanks partly to Abenomics.

Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo, said the second quarter contraction was within his expectations, but the slowdown reflected not only the tax hike but also lower incomes and price increases from other sources.

"The impact from the tax is going to be short-term," Ueno said. "But the economy is ailing, and that's not good."

Public spending could prop up growth in the near term, he said. Even then, it will be hard for any expansion to immediately and totally make up for the big drop for the latest quarter, he said.

Dramatic wage increases are not likely in Japan, and the recent trend of rising prices is part of Abe's strategy to reverse Japan's debilitating spiral of deflation, or falling prices.

Others were more optimistic.

"We believe real GDP will return to growth exceeding potential," in the next quarter, Kyohei Morita and Yuichiro Nagai of Barclays said in a report.

They noted leading economic indicators have started to turn up already, such as public works and housing construction orders.

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Follow Yuri Kageyama on Twitter at https://twitter.com/yurikageyama

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