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UPDATE 1-Japan May core machinery orders unexpectedly fall, gov't downgrades outlook

outlook@

* May core orders -3.6 pct m/m vs forecast +1.7 pct

* Core orders +0.6 pct yr/yr vs forecast +7.7 pct

* Capex seen crucial for economic growth

(Adds details, govt assessment) TOKYO, July 10 (Reuters) - Japan's core machinery orders unexpectedly tumbled in May, and the government downgraded the outlook for orders for the first time in eight months, raising doubts about the strength of the economic recovery. The result is also particularly surprising given recent signs of an upswing in momentum, and suggests policymakers will have their work cut out in their quest to foster sustainable growth, especially if businesses show reluctance to invest. Core orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, dropped 3.6 percent in May from the previous month, Cabinet Office data showed on Monday. That sharply undershot the 1.7 percent increase expected by economists in a Reuters poll, and followed a 3.1 percent drop in April. The government cut its assessment of machinery orders for the first time in eight months, saying they are stalling in a worrying sign businesses may be turning cautious on investing. Japanese policymakers hope capital spending will help revitalize the world's third-largest economy and pull it out of years of deflation and stagnation. Recent data suggested momentum was picking up, though it wasn't clear if the economic recovery was broadening out. Japan's economy expanded an annualized 1.0 percent in the first quarter on robust exports and household spending, while business confidence hit a three-year high in the three months to June. Compared with a year earlier, core orders, which exclude ships and orders from electric power utilities, grew 0.6 percent in May, versus the 7.7 percent growth expected by economists and the 2.7 percent rise in April. in May from the previous month. Orders from the services sector fell 5.1 percent, down for a third straight month.

(Reporting by Minami Funakoshi; Editing by Chang-Ran Kim & Shri Navaratnam)