Japan's industrial output unexpectedly fell in July as a slowdown in exports to China and Europe led electronics and semiconductor markers to trim output in a troubling sign that Japan's broad economy is weakening.
The 1.2 percent decline in output in July compares with a median estimate for a 1.7 percent increase, according to a Reuters poll and follows a 0.4 percent gain in June.
In a further sign of trouble ahead, the purchasing managers index for August showed manufacturing activity languished at the lowest level since last year's earthquake as domestic and external demand suffer.
Manufacturers said they expect output to rise only modestly in August and then fall again in September, which could increase the chance that the economy will contract in the third quarter and pressure policymakers to bolster growth.
"Exports to China and the European Union have been decreasing, so electronics parts makers are cutting back on production to adjust inventories," said Seiji Adachi, senior economist at Deutsche Securities.
"Forecasts for August and September show that output is on a downtrend."
Manufacturers surveyed by the trade ministry expect output to rise 0.1 percent in August and then decrease 3.3 percent in September.
The Markit/JMMA Japan Manufacturing Purchasing Managers Index (PMI) fell to a seasonally adjusted 47.7 in August from 47.9 in July. The index reached the lowest level since April 2011, one month after the earthquake struck Japan's northeast coast.
The core consumer price index (CPI), which includes oil products but excludes volatile prices of fresh fruit, vegetables and seafood, in July fell 0.3 percent from a year earlier, separate data showed. That matched the median estimate, showing that deflationary pressure remains persistent.
The so-called core-core inflation index, which excludes food and energy prices and is similar to the core index used in the United States, fell 0.6 percent in the year to July, data from the internal affairs ministry showed.
Japan's economy has so far outpaced growth of most G7 countries on solid private consumption and reconstruction spending.
But exports in July posted the sharpest annual drop in six months, in line with trends seen in other export-driven Asian economies, casting doubt on Japan's recovery prospects.
The Bank of Japan frets that the timing of a recovery may be delayed, but wants to hold off on easing monetary policy again -- after having acted in February and April -- unless risks heighten enough to kill any chance of a recovery.
Should the economy require more fiscal stimulus, the policy response could be delayed as the government is locked in a dispute with opposition parties over foreign policy.
(Writing by Stanley White; Editing by Jacqueline Wong)