TOKYO, Oct 30 (Reuters) - Japan's factory output rebounded in September on firm domestic demand as gradually building strength in the world's third-largest economy compensated for slowing exports to the rest of Asia. The gain was a bit less than expected and manufacturers expect output to continue an uneven expansion in the coming months, underscoring the view Japan's recovery remains moderate and reliant on Prime Minister Shinzo Abe's stimulus policies. Industrial output rose 1.5 percent in September from August, less than a median market forecast of a 1.8 percent increase but bouncing back from a 0.9 percent decline in August, data from the Ministry of Economy, Trade and Industry showed on Wednesday. The government raised its assessment of output for the first time in six months, saying it is picking up. Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo, agreed that the data show "a clear pick-up in factory output led by firm domestic demand." But some of the strength will be short-lived, reflecting a burst of last-minute spending that will increase before the government raises the national sales tax in April, he said. And "overseas demand remains unstable." Brisk domestic and U.S. demand for cars, and increasing orders by banks for big computer systems were largely behind the output rise, a METI official said in a briefing. Manufacturers surveyed by the ministry expect output to rise 4.7 percent in October but decrease 1.2 percent in November. Japan's economy expanded for a third straight quarter in April-June, outpacing its Group of Seven counterparts, as the feel-good mood generated by Abe's policies bolstered business sentiment and personal consumption. But export growth fell well short of expectations in September due to slowing demand in Asia, dampening policymakers' hopes that exports would pick up in time to make up for a downturn in household spending when the sales tax goes up. The output index, at 98.5, was the highest since May last year. The previous peak was 100.6 marked in April last year. Output rose 1.8 percent in the July-Sept quarter from the previous quarter, the third straight quarter of increase. The output data will likely be among factors Bank of Japan policymakers will scrutinise on Thursday, when they review policy and issue new long-term economic and price forecasts. The BOJ is expected to keep monetary settings unchanged and revise up its economic forecast for next fiscal year only slightly, with sluggish global demand offsetting much of the boost from a government fiscal stimulus package. "The central bank will probably slightly raise its economic growth projection tomorrow as the second-quarter growth figures came out stronger than initially thought," Minami said. But despite the recovery, he said it will be difficult for the BOJ - fighting to end 15 years of falling prices - to hit its inflation target of 2 percent in two years. "Inflation is unlikely to pick up pace even though upward pressures on prices are on the rise."
(Additional reporting by Tetsushi Kajimoto; Editing by William Mallard and John Mair)