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Japan economy still struggling with tax hike, data show

Despite mixed data, this expert still likes Japan

Japan has not fully adjusted to the April sales tax hike, analysts told CNBC following a deluge of data on Tuesday.

Retail sales rose 1.2 percent on year in August, above expectations for a 0.3 percent rise in a Reuters poll and up from a 0.6 percent rise in July, data showed on Tuesday.

However, household spending fell 4.7 percent on year, worse than expectations for a 3.8 percent decline, while industrial production fell 1.5 percent on month, below expectations for a 0.2 percent rise.

Read MoreJapan's core consumer prices rose 3.1% in August

"Obviously we're still dealing with the effects of the tax [hike] in April. The third arrow [of Abenomics] was going to be difficult we know," said Martin Schulz, managing director of international equities at PNC Capital Advisors.

Takuji Okubo, principal and chief economist at Japan Macro Advisors, told CNBC he was particularly concerned about the drop in industrial production.

"The low point was the industrial production. We've had two quarters of consecutive decline in production... so they are experiencing a technical recession. So that is definitely bad news, and this also has impacts for exports and capital investment," he said.

"With consumers suffering under the weight of consumption tax it has to be exports or capital expenditure that drives the Japanese economy, but from what we're seeing in industrial production that doesn't seem to be happening, so the Japanese economy is basically without a driver," he added.

Dimas Ardian | Bloomberg| Getty Images

Bright spot

It wasn't all doom and gloom, however, and most analysts were positively surprised by the uptick in retail sales.

"Retail sales was quite a shocker," said Nicholas Smith, Japan strategist at research house CLSA.

"Obviously we had unbelievable weather conditions with half the sunlight of normal and massive typhoons, but even so, people were out spending, which was a real surprise to me, and the reasons were pretty clear: they had a payment of very decent bonus in July and they went and had some retail therapy on it," he said.

Japan Macro Advisors' Okubo was also positive on that aspect of the data.

"It does suggest that the consumers seem to be moving out of a funk or negative shock from the consumption tax hike. So retail sales gives a little hope that the Japanese economy may be regaining positive momentum," he added.

However, he pointed out that rising consumer spending could lead to a decline in the savings' rate, which could introduce risks into the economy.

To hike or not to hike?

In April, the government raised the consumption tax to 8 percent from 5 percent to rein in the country's budget-to-GDP ratio. It was the first tax hike in 17 years.

Analysts have said the performance of Japan's economy over the third quarter will likely determine whether the government proceeds with a second tax hike to 10 percent in 2015.

But CLSA's Smith doubts Japanese authorities would budge on their plan to proceed with a second hike.

"The authorities feel they have no alternative and I would assume it's going to go ahead. Backing out of it would be an open admission that Abenomics had failed, which would be politically disastrous," he added.

Prime Minister Shinzo Abe kick-started his ambitious economic reform plan - known as Abenomics - in late 2012. The three-pronged plan involves aggressive monetary easing, fiscal spending and structural reform.

Among other Japanese data points released Tuesday, the jobless rate unexpectedly shrank to 3.5 percent in August from 3.8 percent in July. Expectations were for a flat reading.

However, CLSA's Smith said the jobs reading was encouraging in his view.

"Actually the number of people in employment didn't worsen when it moved to 3.8 percent. It's a similar problem to the U.S. the job market [in Japan] is unbelievably tight, which is good for wages which is the main thing we need at the moment," he said.

Meanwhile, the job-to-applicants was 1.10, unchanged from July when it reached its highest level since June 1992.