Japanese business sentiment worsened for a second straight quarter in the three months to December and will barely improve early next year, a central bank survey showed, as the global slowdown and a territorial row with China hit the export-reliant economy.
The dismal reading heightens the case for the Bank of Japan, already under intense political pressure for bolder action ahead of Sunday's general election, to ease monetary policy further next week to support an economy already in recession.
"Both manufacturers and non-manufacturers were worse than expected. Declines in exports are hurting manufacturers, but for non-manufacturers, the numbers show that the benefits of reconstruction spending are starting to fade," said Shuji Tonouchi, senior fixed income strategist at Mitsubishi UFG Morgan Stanley Securities in Tokyo.
"There were already expectations for the Bank of Japan to ease policy after the Federal Reserve's move. The tankan results support further easing by the BOJ."
Big manufacturers' mood soured for the second straight quarter with the headline sentiment index falling 9 points from September to minus 12, worse than a median market forecast of minus 10, the BOJ's closely-watched tankan quarterly survey showed on Friday.
In a sign the pain from weakening exports was broadening, service-sector sentiment worsened 4 points to plus 4, the first decline in six quarters. Sectors that had benefited from reconstruction spending after last year's earthquake such as construction and transport took a hit.
Big manufacturers expect conditions to barely improve and non-manufacturers project a further deterioration in business three months ahead, the survey showed, as the global slowdown persists and domestic demand starts to lose support from spending for reconstruction.
The BOJ is thus likely to ease policy at its December 19-20 meeting, sources say, to prevent risks such as the potential fallout from the U.S. "fiscal cliff" from further threatening Japan's recovery prospects.
"If the BOJ was leaning toward easing policy, this tankan survey will give them a nudge in that direction. There are not any signs that sentiment will recover quickly," said Hiroshi Miyazaki, chief economist at Shinkin Asset Management in Tokyo.
Japan's economy shrank for a second straight quarter in July-September and analysts expect another contraction in the final three months of this year as a territorial row hit sales of Japanese goods in China, adding to the pain for exporters already suffering weak global demand.
Many analysts agree with the BOJ that Japan will emerge from mild recession early next year, although central bankers fret that any recovery will be slow and weak.
In a rare positive sign, the tankan showed big firms expect a 6.8 percent rise in capital spending in the fiscal year to next March, roughly unchanged from its projection in September and stronger than a median forecast of a 5.0 percent increase.
Recent falls in the yen, driven by expectations of further BOJ easing, will also help corporate revenues. The dollar hovered around 83.60 yen on Friday, well above the average of 78.90 yen projected for this fiscal year by big manufacturers in the December tankan survey.
Still, sentiment worsened in a broad range of industries including auto and machinery makers - key drivers of Japan's economy - as slumping sales in emerging economies took a toll.
(Read more: Japan Machinery Orders Up, but Outlook Uncertain)
Automakers expect conditions to deteriorate further in the three months ahead, despite an easing of losses from anti-Japan protests that flared up from a territorial row with China in September and hit sales of Japanese cars.
The tankan's sentiment indexes are derived by subtracting the percentage of respondents who say conditions are poor from those who say they are good. A negative reading means pessimists outnumbered optimists.
The survey, a key touchstone for BOJ policymakers, is largely in line with showings in the Reuters Tankan last week that manufacturers' sentiment soured from three months ago. That survey closely correlates with the BOJ tankan.