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Japan's economy slumps back into decline as COVID-19 hits spending

By Leika Kihara and Tetsushi Kajimoto

TOKYO (Reuters) - Japan's economy shrank more than expected in the first quarter as a slow vaccine rollout and new COVID-19 infections hit spending on items such as dining out and clothes, raising concerns the country will lag others emerging from the pandemic.

Capital expenditure also fell unexpectedly and export growth slowed sharply, a sign the world's third-largest economy is struggling for drivers to pull it out of the doldrums.

The dismal reading and extended state of emergency curbs have heightened the risk Japan may shrink again in the current quarter and slide back to recession, defined as two straight quarters of recession, some analysts say.

"Global chip shortages caused a marked slowdown in exports, putting a drag on capital spending as well," said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities.

"Consumption will probably remain stagnant, raising risks of an economic contraction in the current quarter."

The economy shrank an annualised 5.1% in the first quarter, more than the forecast 4.6% contraction and following an 11.6% jump in the previous quarter, government data showed on Tuesday.

The decline was mainly due to a 1.4% drop in private consumption as state of emergency curbs to combat the pandemic hit spending for clothing and dining out.

But the bigger-than-expected contraction also reflected a surprise 1.4% drop in capital expenditure, which confounded market expectations for a 1.1% increase as companies scaled back spending on equipment for machinery and cars.

While exports grew 2.3% thanks to a rebound in global demand for cars and electronics, the pace of increase slowed sharply from the previous quarter's 11.7% gain, a worrying sign for an economy still reeling from weak domestic demand.

Domestic demand knocked 1.1% point off gross domestic product (GDP), while net exports shaved off 0.2 point, the data showed.

"That domestic demand is weak shows the adverse effects from the coronavirus haven't been shaken off at all," said Takeshi Minami, chief economist at Norinchukin Research Institute.

Despite massive monetary and fiscal stimulus, Japan's economy slumped a record 4.6% in the fiscal year that ended in March, the data showed.

"There will undoubtedly be fiscal money poured on this problem to soften the blow, though after so much already, it is difficult to see this having more than a fairly marginal effect," analysts at ING wrote in a research note, adding they expect the economy to shrink again in the current quarter.

"And the Bank of Japan seems to be out of fresh policy stimulus ideas currently, so we don't anticipate anything new from them apart from extending existing measures."

Economy Minister Yasutoshi Nishimura blamed the weak GDP reading mainly on the curbs to combat the pandemic, adding the economy still had "potential" to recover.

"It's true service spending will likely remain under pressure in April-June. But exports and output will benefit from a recovery in overseas growth," he told reporters.

Japan's economy expanded for two straight quarters after its worst postwar slump in April-June last year due to the initial hit from the pandemic.

The export-driven recovery came to a standstill as consumption took a hit from a spike in new virus strains that forced the government to re-impose curbs just 10 weeks before the Tokyo Olympic Games.

(Reporting by Leika Kihara and Tetsushi Kajimoto; Additional reporting by Daniel Leussink; Editing by Sam Holmes)