Oil drives Japan inflation to highest in decade

TOKYO (Reuters) - Rising oil prices drove Japanese annual inflation to its highest level in nearly a decade in November, but that did not rekindle expectations of a Bank of Japan interest rate hike as the economic outlook remains murky.

Weakness in other data released on Friday, including a fall in job offers to a two-year low, underscored the difficulty the Bank of Japan faces as a long-awaited return to rising prices coincides with a softening outlook.

The rise in inflation is driven almost entirely by higher gasoline prices, which works like a tax on consumers, and economists warned of weakening consumer sentiment and the prospect of stagflation from oil-fuelled price rises.

"Gasoline prices are continuing to rise, so we expect nationwide consumer prices to keep rising in December," said Yoshiki Shinke, senior economist at Dai-ichi Life Research Institute.

"But such price gains are negative for the economy as they could hurt consumer sentiment," he said. "As such, it's hard for the Bank of Japan to justify raising rates just because consumer prices are rising."

The nationwide core consumer price index rose 0.4 percent in November from a year earlier, topping market expectations for a 0.3 percent increase, after a 0.1 percent rise in October. Core prices include oil products but exclude fruit, vegetables and fresh seafood.

It was the highest annual rise since a 1.8 percent gain marked in March 1998, when inflation was propped up by a 2-percentage-point hike in Japan's broad sales tax.

Financial markets, focused on global issues, did not react much to the data. .T

Swap contracts on the overnight call rate are pricing in almost no chance of a rate hike by March, when current BOJ Governor Toshihiko Fukui retires, and only around a 40 percent chance by the end of next year.

Concerns over the global credit crisis and plummeting construction activity due to tighter building rules introduced in June have quashed expectations of a BOJ rate hike to 0.75 percent from current 0.5 percent, once considered a near certainty by the end of this year.

Reflecting investors' caution on Japanese economy, Nikkei share average .N225 lost 11.1 percent in 2007, the first annual decline in five years, making it the world's worst-performing major stock market.

The BOJ downgraded its economic assessment last week, saying Japan's growth was slowing. Some BOJ officials have also recently acknowledged that strong corporate earnings have not spilled over to households through employment as much as they had expected.

Japanese wage earners' total cash earnings fell 0.2 percent in November from a year earlier, the 11th fall in the past 12 months, other data showed on Friday. ID:nTKU002956

Japan's seasonally adjusted jobless rate in November unexpectedly fell to 3.8 percent from 4.0 percent in October.

But economists focused on a fall in the jobs-to-applicants ratio to 0.99, meaning 99 jobs were available per 100 applicants. The decline from 1.02 in October signaled that an improving job market might be stalling.

Still, strong growth in the world economy has so far supported Japanese export industries, and hence their production.

Industrial output fell 1.6 percent in November from a month earlier, slightly less than a market forecast for a 1.7 percent drop.

Officials said that was a result of a big rise in output in the previous month, and manufacturers expect their output to rise 4.0 percent in December, government data showed.

"On the whole, the data confirmed production remains on a rising trend," said Junko Nishioka, senior economist at ABN Amro Securities. "The rise in inventories is also slowing in the electronic sector."

Household spending fell 0.6 percent in November from a year earlier in price-adjusted real terms, falling short of a median market forecast for a 0.4 percent rise.

November retail sales rose 1.6 percent from a year earlier, topping market forecasts for a 0.9 percent rise.

(Additional reporting by Tokyo Policy Desk; Editing by Rodney Joyce)