By Kantaro Komiya

TOKYO (Reuters) – Japan’s factory output shrank at the fastest pace in eight months in January as declining overseas demand took a heavy toll on key industries such as auto and semiconductor equipment.

In contrast, retail sales posted their fastest growth in nearly two years, separate data showed, highlighting the divergent paths between soft manufacturing and robust service-sector activity.

“Weak export-bound production and a recovery in consumption continue to be the two main focuses of Japan’s economy,” said Atsushi Takeda, chief economist at Itochu Economic Research Institute. He expects the new Bank of Japan leadership will be slow to tweak monetary policy amid the uncertainty.

Factory output fell 4.6% in January from a month earlier on a seasonally adjusted basis, government data showed on Tuesday. The contraction was much larger than economists’ median forecast of a 2.6% decline and followed an upwardly revised 0.3% increase in December.

It marked the fastest decrease since May 2022’s 7.5% fall, when China’s COVID-19 lockdown disrupted Japanese manufacturers’ supply chains.

Output of auto products slumped 10.1%, dragging the overall index lower while manufacturing of items such as production machinery and electronic parts dropped 13.5% and 4.2%, respectively.

Semiconductor-making equipment was down 26.8% as chip firms slowed their capital expenditure, while passenger cars fell 7.4% due in part to component supply bottleneck caused by heavy snow across Japan, a Ministry of Economy, Trade and Industry (METI) official told reporters.

The United States-led export control of chip equipment against China “has not had an immediate effect” on Japanese industrial production in January, the official added.

GRAPHICS: Japan’s factory output posts biggest fall in 8 months (https://www.reuters.com/graphics/JAPAN-ECONOMY/OUTPUT/dwvkdzzeypm/chart.jpg)

The magnitude of the slowdown was partly due to the early start to the Lunar New Year this year, which started just 22 days after the turn of the calendar year,” said Darren Tay, Japan economist at Capital Economics, adding production will rebound in February.

Manufacturers surveyed by METI expect output to rise 8.0% in February and gain 0.7% in March, the data also showed, although the official poll tends to report an optimistic outlook.

Separate data showed Japanese retail sales rose 6.3% in January from a year earlier, beating a median market forecast for a 4.0% gain and posting an eleventh consecutive month of expansion. It also logged the fastest growth since May 2021.

Despite the production cuts, retail sales of autos rose 19.3% year-on-year, suggesting strong pent-up demand among domestic consumers caused by delivery delays.

Compared with the previous month, retail sales expanded 1.9% in January, following a 1.1% rise in December, the data showed.

Japan’s economy, the world’s third-largest, is expected to post an annualised 1.4% expansion in January-March according to a Reuters poll, after weaker-than-expected 0.6% growth in the final quarter of 2022.

Kazuo Ueda, an academic nominated to become the Bank of Japan’s next governor from April, has stressed the need to maintain the current ultra-low interest rates to support the fragile economy, while signalling the chance of tweaking the central bank’s long-term yield control scheme.

As Ueda has said, Japan won’t be able to escape deflation until the economic recovery is achieved,” said Itochu’s Takeda.

So he wouldn’t hurry policy tweaks that could give a strong shock to the economy, such as a sharp rise in interest rates.”

(Reporting by Kantaro Komiya; Graphics by Pasit Kongkunakornkul; Editing by Shri Navaratnam and Sam Holmes)