Japanese business confidence has sagged since an April sales tax hike came into force, pushing up prices, in the first deterioration in six quarters, a Bank of Japan report showed Tuesday.
The Tankan survey for the April-June quarter showed confidence among large manufacturers stood at plus 12, well short of market expectations, after hitting a more than six-year high of plus 17 in the preceding quarter.
The latest reading marked the first decline since Prime Minister Shinzo Abe took office in late 2012 on a pledge to kick-start the world's number-three economy, and throws into question the strength of Japan's recovery.
The Tankan reading for large companies in the non-manufacturing sector tumbled to plus 19 from plus 24 in the March quarter, also the first downturn in six quarters.
The business sentiment index marks the difference between the percentage of firms that are upbeat and those that see conditions as unfavourable. A positive figure means there are more optimistic business managers than pessimistic ones.
The closely watched survey ofmore than 10,000 companies is the most comprehensive indicator yet of how Japan is coping with the impact of the nation's first sales tax rise in 17 years.
Consumer spending turned down after Japan raised its sales tax from 5.0 percent to 8.0 percent on April 1, with millions of shoppers making a last-minute dash to stores ahead of the increase.
The rise was seen as crucial for shrinking Japan's mammoth national debt, one of the worst among wealthy nations. However there were fears it would slam the brakes on growth and possibly derail Abe's plan to turn around the economy.
The Tankan survey came a day after government data showed that Japan's factory output rose a smaller-than-expected 0.5 percent in May from a month earlier.
- Q3 recovery expected -
Household spending and housing starts have also turned down as Japanese consumers face higher prices due to the tax rise and creeping inflation -- the result of the central bank's efforts to conquer years of deflation and slow growth.
However, other recent data showed Japan's jobless rate edged down to 3.5 percent in May, the lowest level in nearly 17 years, with signs of a tightening labour market.
That will add pressure on firms to raise wages to attract workers, economists said, after major companies wrapped up spring labour negotiations with pay rises for the first time in years.
Also on a brighter note, the Tankan showed big firms' plans for capital spending were picking up since the last survey and many economists expect activity to recover in the third quarter.
"While today's Tankan points to a contraction in GDP of around 0.5 percent... last quarter, the survey suggests that the recovery will resume in the second half of the year," said Marcel Thieliant of Capital Economics.
Abe swept to power on a ticket to nudge the economy out of a cycle of falling prices and lacklustre growth, which saw consumers put off purchases in the hopes of getting goods cheaper down the road.
That, in turn, hurt producers and held back their expansion and hiring plans.
The last time Japan brought in a higher sales levy, in 1997, it was followed by years of deflation and tepid economic growth that defined the country's protracted slump.