Japan's industrial output rose 1.2% in June from a month earlier for the first increase in four months, a sign that the economy's weakest link is recovering and the Bank of Japan could still be on track to raise rates.
But a crushing defeat for Prime Minister Shinzo Abe's coalition in Sunday's upper house election could complicate the outlook for monetary policy and scale back market expectations for a central bank rate hike next month, analysts said.
The increase in June output beat a median market forecast for a 1.1% rise. Manufacturers were also bullish about the outlook, forecasting a 1.8% rise in output in July and a 4.9% increase in August, government data showed on Monday.
"The output outlook for July and August is fairly strong. For July, even if we subtract the negative impact of the recent earthquake on output, which is estimated at around 0.8 percentage point, it would still be 1.0% and this is pretty firm," said Takehiro Sato, an economist at Morgan Stanley. "The latest data is supportive of the Bank of Japan's rate hike," he said.
A Trade Ministry official said the forecast was from a survey conducted before the July 16 quake in northwest Japan. Financial markets did not react much to the data. But the Nikkei 225 Average fell 1%, partly on jitters over the ruling coalition's election defeat.
Analysts said the threat of policy paralysis could hurt Tokyo shares, boost bonds and add to doubts about the timing of Japan's next interest rate hike, but investors were more focused on a broader shake-out triggered by problems in U.S. credit markets.
"Overall, the Japanese economy seems to be moving in line with the BOJ's scenario of solid growth, so I won't be surprised if it raises rates in August," said Noriaki Haseyama, an economist at Dai-ichi Life Research Institute. "But if the (political) uncertainty lasts long, it could make it tougher for the BOJ to raise rates next month," he said.
Economists say production is seen to have fallen in July as carmakers were forced to halt production temporarily after the earthquake. But they say output will likely return to a rising trend after that.
For the whole of the April-June quarter, output rose 0.1% from the previous quarter.
The Ministry of Economy, Trade and Industry, which compiles the data, maintained its assessment that production is leveling off.
Expectations that the BOJ will raise interest rates at its Aug. 22-23 meeting, once taken as highly likely by markets, have retreated last week on fears over the health of U.S. credit markets.
The BOJ has said it will need to gradually raise interest rates as the Japanese economy is expected to continue expanding, which is bound to push up prices at some point in the future.
Most analysts have been expecting the BOJ to raise its key overnight call rate target to 0.75% next month, up from the 0.5% level to which it raised the rate in February.