Japan's economy unexpectedly slipped into recession in the third quarter, setting the stage for Prime Minister Shinzo Abe to delay an unpopular sales tax hike and call a snap election halfway through his term in office.
Gross domestic product (GDP) fell at an annualised 1.6 percent pace in July-September, after it plunged 7.3 percent in the second quarter following a rise in the national sales tax, which clobbered consumer spending.
The world's third-largest economy had been forecast to rebound by 2.1 percent in the third quarter, but consumption and exports remained weak, saddling companies with huge inventories.
Abe had said he would look at the data when deciding whether to press ahead with a second increase in the sales tax to 10 percent in October next year, as part of a plan to curb Japan's huge public debt, the worst among advanced nations.
Japanese media have said the prime minister, who returns from a week-long tour to China, Myanmar and Australia on Monday, could announce his decision to delay the hike as early as Tuesday and state his intention to call a poll, which ruling party lawmakers expect to be held on Dec. 14.
The economic slide was "shocking," an Abe economic adviser said, calling for the government to consider measures to support the economy.
"This is absolutely not a situation in which we should be debating an increase in the consumption tax," Etsuro Honda, a University of Shizuoka professor and a prominent outside architect of Abe's reflationary policies, told Reuters.
"Debate needs to focus on how to support the Japanese economy."
Even before the GDP announcement, Abe appeared to suggest he was leaning toward delaying the tax hike.
"Raising the tax rate is meant to increase tax revenue," he told reporters travelling with him in Brisbane, Australia, on Sunday. If we return to deflation, it would all be for nothing."
Koya Miyamae, senior economist at SMBC Nikko Securities, said broad weakness in the GDP data mean "it's definite there will be a tax-hike delay and a dissolution of the Lower House."
The yen slipped on the poor GDP reading, with the dollar briefly pushing to a seven-year high above 117 yen. The benchmark Nikkei stock average fell 2 percent.
Sluggish economic growth and downward pressure on inflation due to sliding global oil prices prompted the Bank of Japan to expand its massive monetary stimulus last month, surprising financial markets.
No election for parliament's powerful lower house need be held until late 2016, but political insiders say Abe wants to lock in his mandate while his ratings are still relatively robust, helping him push ahead with economic and other policies such a controversial shift away from Japan's post-war pacifism.
"This will not be an election about the sales tax but to seek support for a push forward with 'Abenomics'," said a Japanese government official, adding the final decision was up to Abe.
Abe's Liberal Democratic Party (LDP) is expected to keep its majority in the lower house, since the opposition is divided and weak, but it could well lose seats. As election talk was heating up a week ago, a poll by public broadcaster NHK found that Abe's approval rating had fallen 8 percentage points to 44 percent from a month earlier.
Sales tax fallout
Abe inherited the sales tax plan when he took power in December 2012, pledging to revive the economy with his "Abenomics" mix of ultra-easy monetary policy, spending and reforms.
The LDP, its smaller ally and the then-ruling Democratic Party enacted the legislation requiring the tax to be raised unless economic conditions were judged too weak.
Economy Minister Akira Amari said the GDP data showed that the impact of the April tax hike was bigger than expected in preventing the public from shaking off their deflationary mindset.
Household spending is stagnating, while housing investment and corporate capital spending were down, Amari said, while finding a bright spot in strong corporate profits.
On a quarter-on-quarter basis, the economy shrank 0.4 percent in the third quarter, following a contraction of 1.8 percent in the second quarter. Recessions are typically defined as two or more consecutive quarters of economic contraction.
Private consumption, which accounts for about 60 percent of the economy, rose 0.4 percent from the previous quarter, half as much as expected, in a sign that the April tax increase to 8 percent from 5 percent had a stronger and more lingering impact on spending than initially expected.