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UPDATE 2-Japan machinery orders fall most in 8 months in worrying sign for economy

7.4% in the fiscal year to March 2020.

economy@

* May core orders -7.8% mth/mth vs forecast -4.7%

* Core orders -3.7% yr/yr in May vs forecast -3.9%

* Capex had been seen as bright spot in economy

* External risks may weigh on capex ahead

(Adds analyst's comment on capex, context) TOKYO, July 8 (Reuters) - Japan's core machinery orders fell tensions are taking a toll on corporate investment, casting doubt that solid domestic demand can help offset external pressure on the export-reliant economy. Any downturn in business spending will hurt prospects for stronger wage growth and dampen the central bank's hopes a sustained economic recovery will prod firms to boost prices and wages, helping to reach its 2 percent inflation goal. Cabinet Office data on Monday showed that core orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, fell 7.8% in May from the previous month. The reading, the biggest drop since September 2018 and down for the first time in four months, compared with a 4.7% decline seen by economists in a Reuters poll and followed a 5.2% rise in April. Policymakers are counting on domestic demand to offset risks such as the Sino-U.S. trade war and slowing global demand that could threaten to derail the world's third-largest economy. Capital expenditure has been a bright spot in the fragile economy, helping first-quarter gross domestic product to expand at an annualized rate of 2.2%. However, external risks cloud the outlook for Japan's export-dependent economy, which would weigh on Japanese business confidence and could in turn put a drag on capital expenditure. That could fan concerns about domestic demand just as Prime Minister Shinzo Abe's government is set to raise the national sales tax to 10% in October. "Despite a slump in May, machinery orders point to broadly stable capital spending in the second quarter. Even so, we expect investment growth to slow sharply over the coming quarters," said Marcel Thieliant, senior Japan economist at Capital Economics. "Resilience is unlikely to last. Firms have revised down their capital spending plans in light of weaker external demand. And consumer spending is set to slow after October's sales tax hike."

SALES TAX HIKE The previous tax hike to 8% from 5% in April 2014 dealt a blow to consumers and triggered a deep economic slump. Since then, Abe has twice delayed a planned sales tax hike. The Cabinet Office maintained its assessment on machinery orders to say they are showing a pick up. from the previous month, swinging sharply lower from the prior month's 16.3% gain, while those from the service-sector dropped 9.0%, down for the first time in three month, the Cabinet Office data showed. The data comes a week after the Bank of Japan's quarterly tankan survey showed solid Japanese business expenditure plans, with big firms planning to raise their capital expenditure plan The BOJ will scrutinize the tankan results and a batch of other indicators at its policy-setting meeting later this month when it issues fresh economic and price projections. Japan's capital expenditure has been driven by demand for boosting labor-saving technology to cope with a labor crunch in the fast-aging population, high-tech investment and upgrading old plant and equipment.

(Reporting by Tetsushi Kajimoto Editing by Jacqueline Wong)