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TOKYO (Reuters) - Japan's economy is still expected to outperform most of its developed nation peers this year thanks to solid domestic demand, but analysts have slashed forecasts for factory output as the slowdown in the global economy becomes more pronounced.
The world's third-largest economy is set to grow by 2.2 percent in the year to next March, according to a Reuters poll of economists, slightly slower than the 2.3 percent pace seen in a similar survey in June.
Analysts also trimmed the possibility of Japan slipping back into recession in the next twelve months to 25 percent, compared with 30 percent in polls in May and June.
However, cooling growth in China and the United States, on top of Europe's deepening economic and fiscal troubles, prompted analysts to sharply cut their forecasts for Japan's factory output.
"Previously, we projected overseas economies would pick up in the second half of this year. But the pace of growth in China slackened and a slowdown in industrialized nations is becoming distinct," said Junko Nishioka, chief economist at RBS Securities.
Japan's industrial output will rise 3.6 percent in the current fiscal year and 3.2 percent in the next, according to the poll of 27 economists conducted between July 10-17.
Those figures compared with increases of 5.6 percent and 3.5 percent, respectively, seen in the April poll.
Rebuilding efforts from last year's earthquake and tsunami and solid private spending led by government subsidies on low-emission cars will help offset the global downdraft to some extent this year.
But momentum is expected to slow in the next fiscal year, with GDP growth seen cooling to 1.5 percent, compared with a forecast of 1.4 percent in the June poll.
Mitsubishi UFJ Morgan Stanley Securities said it sees external demand contributing only 0.2 percentage points to its 2.3 percent growth forecast for the current fiscal year.
"We see downside risks to exports as Europe's real economy is unstable, and the pace of growth in emerging nations is still easing," said Shuji Tonouchi, senior fixed income strategist at the securities firm.
The Band of Japan last week held off on further policy easing, with Governor Masaaki Shirakawa signaling the central bank was in no mood to follow its global counterparts and launch fresh stimulus measures any time soon.
Mounting political pressure, however, could prompt the BOJ to ease policy again later in the year if global economic conditions continue to deteriorate and the domestic recovery loses steam.
Shirakawa's first term will end in early April 2013 and analysts see only a 20 percent chance that he will be reappointed to the post, according to the poll. Their views were more split, however, on whether he should be appointed for a second term.
Many economists believe Japanese politicians will seek a new governor who will be more aggressive towards easing to help the economy. Parliament's recent approval of nominations of two prominent economists to the BOJ's board, including a vocal advocate of aggressive monetary easing, bolster that view.
Masayuki Kichikawa, chief economist at the Bank of America Merrill Lynch in Tokyo, projects Japan's recovery will continue if another global credit crunch like that seen in 2008/09 is avoided.
Movements in the yen will remain a key focus of Japanese policymakers, he added.
"The BOJ will probably hold its passive stance towards taking additional policy steps but there is a high chance it will ease policy if the yen spikes."
The Japanese currency is trading at its highest level since early June against the dollar and Finance Minister Jun Azumi hinted on Tuesday the government is prepared to intervene to stem excessive moves.
So far in 2012 the yen has weakened nearly 2 percent, but has shown bursts of strength as volatile global financial markets spur investors to seek out less risky assets.
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