TOKYO—Japan has officially slipped back into recession mode as the county’s economy unexpectedly contracted in the third quarter, increasing the odds that Prime Minister Shinzo Abe will postpone a controversial sales-tax increase slated for next year.

 

Gross domestic product shrank an annualized 1.6 percent in the three months through September, the Cabinet Office said Monday in Tokyo, compared to the median forecast for 2.2 percent growth in a Bloomberg News survey of economists. Unadjusted for price changes, the economy contracted an annualized 3 percent. Japan’s economy shed 7.3 percent in annualized terms in the second quarter and a recession is defined as two consecutive quarters of contraction.

Abe’s administration is seeking to shore up public support after April’s levy increase triggered the deepest contraction in more than five years. Etsuro Honda, an adviser to the prime minister, said last week a tax increase is out of the question if growth is less than 3.8 percent.

Economists said a delay in the tax hike is almost certain as speculation mounts that Abe will call a snap election, possibly as early as this week.

 

“July-September GDP was the most important factor for deciding on a second consumption tax hike scheduled for October 2015. We think the unexpected contraction has significantly raised the likelihood that the Abe administration will decide to push back the consumption tax hike (to April 2017) after the expert panel finishes meeting on November 18,” Goldman Sachs economist Naohiko Baba said in a research note after the release of Monday’s data.

In a note ahead of he GDP release,  Mizuho Securities Research and Consulting Co. economist Norio Miyagawa said a tax hike delay and snap election seem nearly certain. “Momentum is weak as exports are struggling and the recovery in consumption is weak,” Miyagawa said.

Japan’s third-quarter private consumption rose just 0.4 percent from the previous quarter. That is coming off a very low base as consumption slumped 5 percent in the second quarter in the immediate wake of the first tax hike.

 

Mariko Takemura, senior analyst with Euromonitor, noted a trend of “declining consumer power” in Japan and said a postponement of the second tax increase would help consumers feel more confident next next year.

“After the tax increase in April this year, consumer power did not recover sufficiently, especially in luxury goods and consumer appliances. Furthermore, due to the weak yen and the hike of commodity prices, retail prices of food products have been raised continuously this year, which put more burden on consumers,” she said. “A delay of tax increase will allow more time for the recovery, while it has been considered another tax increase in the next year will further put burden on consumers in 2015.”

Although some luxury goods executives have downplayed the impact of the April’s tax increase, it is clear that Japanese retailers are feeling the effects of higher price tags for consumers. Earlier this month, Isetan Mitsukoshi, the country’s largest department store operator, said its first half sales slid on a fall in consumer spending. The retailer’s sales for the six months ended Sept. 30 slipped 3.5 percent to 581.62 billion yen, or $5.65 billion. The company said that increasing prices for commodities such as gasoline, electricity and foodstuffs have also negatively affected the overall consumer mindset.

 

Fashion manufacturer and retailer Onward Holdings saw a more modest dent in its first half numbers through August, with its sales declining 0.4 percent but a spokesman blamed the fall on April’s tax hike.

 

The 3 percentage point increase in the sales tax in April has pushed up the cost of living, straining households that are pressured by rising prices as the central bank pumps record stimulus. With inflation outpacing wage growth, a further bump in the levy slated for next October risks hurting consumption and undermining Abe’s support.

Abe has the power to call off the hike, the second of the two-stage increase legislated by the previous government, based on the health of the economy. The prime minister is considering postponing the increase until 2017 and calling an election next month, people familiar with the discussions said last week.

The government approved a 5.5 trillion yen, or $43 billion, extra budget in December to help the economy weather April’s tax hike. Finance Minister Taro Aso has signaled readiness to boost stimulus and Abe said last week he would consider compiling an extra budget depending on the economy.

The government is considering measures that may amount to 3 trillion yen to 4 trillion yen, or $25.8 billion to $34.4 billion, to support the economy, according to a Yomiuri newspaper report on Oct. 31.

Abe’s ruling Liberal Democratic Party is considering steps to protect against the impact of a weaker yen and higher energy prices as part of a campaign platform for a possible election, the Nikkei newspaper reported last week, without citing anyone.

A group of LDP lawmakers who want to delay the next bump in the sales levy estimate the government could have as much as 4.6 trillion yen, or $39.6 billion, available for economic stimulus if it doesn’t increase the sales tax next year.

Postponing the planned increase by about 18 months would add about 0.5 percent to growth, the group said in a discussion paper obtained by Bloomberg News. The lawmakers, led by lower house member Kozo Yamamoto, estimate that this expansion would have a bigger impact on the amount of tax raised than increasing the levy and risking another economic contraction.

In 1997, then-Prime Minister Ryutaro Hashimoto oversaw a 2 percentage point boost in the consumption levy. The move cost him his job as Japan sank into a recession with consumption swooning against a backdrop of weakening demand abroad due to the Asian financial crisis.

 

The GDP news dragged down stocks Monday. Tokyo’s Nikkei 225 index shed 2.96 percent to close the session at 16,973.80.


Bloomberg contributed to this report.