TOKYO A year after Prime Minister Shinzo Abe took financial markets by storm with promises to revive the moribund Japanese economy, data showed growth slowed sharply and that his "Abenomics" policy mix is yet to secure a durable recovery.
Growth in the world's third-biggest economy decelerated in the third quarter after leading the Group of Seven industrial powers in the first half of the year, as capital spending, personal consumption and exports moderated.
Thursday's gross domestic product data highlighted the early successes of Abe's aggressive monetary and fiscal stimulus, particularly in buoying domestic demand, and marked a fourth successive quarter of growth, the longest run in three years.
But it also showed the difficulties of translating the feel-good factor into increased business investment or higher wages, which would indicate corporate Japan sees a longer-term pick-up in the economy.
GDP expanded at an annualized clip of 1.9 percent in the July-September quarter, slightly faster than expected by markets but still sharply slower than 3.8 percent in April-June and 4.3 percent in the first quarter.
"It is not something that boosts confidence if the outcome is considered an interim health report for Abenomics. Going forward, the key is whether domestic demand can lead growth," said Hideo Kumano, executive chief economist at Dai-Ichi Life Research Institute.
ONE YEAR ON
Japan's economy has improved dramatically since November 14, 2012, when Abe's unpopular predecessor, Yoshihiko Noda, announced snap elections. That vaulted Abe into pole position and prompted investors to price in the effects of his promises of massive government debt purchases by the central bank, hefty government spending and steps to bolster longer-term growth.
Tokyo shares are up 72 percent in that 12 months and the yen has slid 20 percent, helping exporters and creating a wealth effect that has altered domestic and global psychology about Japan.
But those market gains essentially stalled in May, and skepticism is growing that Abe can deliver the tough decisions that would set Japan's economy on a more sustainable growth path; for example, by letting companies fire workers more freely to open up a new dynamism in the sclerotic labor market.
Some remain bullish. Takashi Hibino, CEO of Daiwa Securities Group (8601.T), said strong earnings could propel the Nikkei stock average .N225 more than 20 percent higher in the fiscal year from next April, hitting the 18,261 peak it reached in 2007 during Abe's first administration.
"Thanks to Abenomics, companies are going to become more aggressive in their management," Hibino said. "I believe the business environment will be good again next year."
Japan's top banks said this week they logged strong July-September profit growth thanks to equity portfolios boosted by the stock surge, but other benefits of Abenomics have yet to spread to their core lending business. Companies remain reluctant to invest and consumer spending has lost steam.
SHORT-TERM REBOUND SEEN
Private consumption, which makes up about 60 percent of the economy, grew 0.1 percent in the September quarter, slowing sharply from 0.6 percent growth in the June quarter as falls in the stock market weighed on consumer sentiment.
Growth will quickly rebound as shoppers rush to spend before a national sales tax is increased to 8 percent from 5 percent in April, economists say. But Abenomics is struggling to gain traction on key areas that would indicate longer-lasting changes to the economy, such as capital spending and wage growth.
Core machinery orders, a key predictor of spending on factories, equipment and software, fell more than expected in September, data showed on Wednesday. A Bank of Japan (BOJ) policymaker warned of headwinds from soft overseas growth, underscoring the challenges facing Abenomics. <ID:L4N0IX0BD>
Still, a tighter labor market and signs from a few major companies of rising wages should support consumer spending in coming quarters, boding well for Abe's push to foster self-sustaining growth and end 15 years of mild deflation.
The BOJ has warned that overseas economies are a little weaker than it had expected, but the central bank raised its GDP forecast for next fiscal year as the government is planning a 5 trillion yen ($51 billion) stimulus package to offset the impact of the sales tax hike.
Exports to Southeast Asia have weakened as large capital outflows out of those countries slowed growth. However, economists expect exports to improve going into next year as overseas economies stabilize.
The BOJ radically expanded its quantitative easing in April, which is aimed at achieving a 2 percent inflation target in roughly two years - although not all board members see that as a realistic goal.
Abe's plan is to combine fiscal spending and economic reforms with BOJ monetary easing to pull Japan out of a decades-long economic slump.
(Additional reporting by Taiga Uranaka and Nathan Layne; Writing by William Mallard; Editing by Neil Fullick and John Mair)