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UPDATE 2-Japan's solid factory output masks trouble ahead as retail sales slump

Daniel Leussink

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* July output rises +1.3% m/m vs forecast +0.3%

* Factory production seen rising in Aug, falling in Sep

* Govt keeps view on output, says moving sideways

* Tokyo August core inflation rate at +0.7% y/y (Adds economists' comments, context on economy & outlook)

TOKYO, Aug 30 (Reuters) - Japan's industrial output rebounded more than expected in July, but retail sales declined sharply and production was set to contract again next month, signaling a bumpy road for an economy facing growing global strains.

Over the past year, Japan's economy and its manufacturers have been pressured by slowing global growth and a protracted trade war between the United States and China, which has disrupted world supply chains and business investment.

Industrial output rose 1.3% in July, government data showed, more than a median market forecast for a 0.3% gain. But that hardly recouped the sharp 3.3% drop in the previous month.

Output was pushed up by increased production of cars and chemicals, offsetting a decline for oil products, the data showed.

"Although the reading for July was positive, it isn't so great seen from a longer perspective," said Akiyoshi Takumori, chief economist at Sumitomo Mitsui DS Asset Management.

"The level of production remains slightly below what it was in April, so looking at it over a three-month period output has declined."

Manufacturers surveyed by the trade ministry expect output to rise 1.3% in August, but fall again by 1.6% in September.

Friday's data set paints a mixed picture for Japan's economy, the world's third-largest, whose outlook has been clouded by global pressures and early signs of weakness in business sentiment.

"These (output) projections tend to be too optimistic and we think that output will be broadly flat in August," Marcel Thieliant, senior Japan economist at Capital Economics, said in a note to clients.

"That means that even if it doesn't fall any further in September, it would shrink a little in the third quarter, consistent with weak GDP growth."

So far, the export-reliant economy has avoided buckling under a slowdown in overseas demand and expanded an annualized 1.8% in the second-quarter, largely thanks to robust household consumption and capital expenditure.

Japanese exporters also hold hopes for a speedy resolution to bilateral trade negotiations between Washington and Tokyo after U.S. President Donald Trump and Prime Minister Shinzo Abe on Sunday announced an agreement on the core principles of a limited trade deal.

But business expectations have dimmed recently. Japanese manufacturers turned pessimistic about business prospects for the first time in more than six years in August as the specter of a global downturn looms large, the monthly Reuters Tankan survey showed last week.

"If one assumes that business sentiment worsens following the sales tax hike, overseas and domestic demand would both be in bad shape, so that would put downward pressure on output from October onwards," said Takeshi Minami, chief economist at Norinchukin Research Institute.

Japan's exports slipped for an eighth month in July as China-bound sales slumped again in a fresh sign the Sino-U.S. trade war could hurt the economy.

Separate data on Friday showed domestic demand might slow in coming months as retail sales dropped 2.0% in July from a year earlier, reflecting recent weakness in household sentiment. It was worse than a median estimate for a 0.8% drop.

Tokyo's core consumer prices (CPI) index, which includes oil products but excludes fresh food prices, rose 0.7% in August from a year earlier. The figure matched the level seen in June last year and was the lowest since May 2018 when the index grew 0.5%.

The price data yet again underlined the uphill task for the Bank of Japan in its quest to push headline inflation to 2.0%.

Nationwide core inflation, excluding fresh food prices, was running at 0.6% in July, wallowing at a two-year low, despite years of super-easy rates and massive stimulus.

The labor market remained resilient, though, with separate data showing the jobless rate fell to 2.2% in July, while the availability of jobs decreased.

The jobs-to-applicants ratio declined to 1.59 in July, down from June and the median estimate of 1.61.

(Reporting by Daniel Leussink, Additional reporting by Kaori Kaneko Editing by Shri Navaratnam)