Japan's economy condition stopped worsening, the outgoing government said on Friday in a monthly report, but it remains weak enough to justify a nudge from monetary and fiscal stimulus planned by the newly elected administration.
In the last monthly assessment produced before Shinzo Abe's cabinet takes over on December 26, the government kept its assessment of the economy's condition unchanged, snapping a four-month run of downgrades that was the longest such sequence since the 2008-09 financial crisis.
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It said, the Japanese economy showed "weakness recently due to deceleration of the world economy", using the same phrase as in November.
"There are some bright spots here and there, but overall, the economy remains weak and we can't be optimistic," a Cabinet Office official in charge of compiling the monthly report told reporters.
"Companies, especially manufacturers, continue to operate in a tough environment and their profits are sluggish, with a drop in exports weighing on production and business sentiment."
The report, followed the Bank of Japan's third shot of monetary stimulus in four months and its fifth this year, mainly in response to growing pressure from incoming Prime Minister Shinzo Abe for bolder action to beat deflation.
But a further 10 trillion yen ($118.50 billion) addition to the BOJ's asset buying and lending pot also reflected the central bank's concern about sagging business confidence apparent in its latest Tankan business survey, economists said.
There is, however, skepticism over how quickly Abe's promised mix of a public spending splurge and aggressive monetary stimulus can translate into a pick-up in growth.
With the yen just above 20-month lows and a 10 percent stock market rally in the past month, markets have already factored in further, possibly intensified BOJ easing in coming months. On Thursday, the central bank signaled it would raise its price goal next month in response to Abe's call for a binding 2 percent inflation target.
Abe's cabinet is expected to draft the extra budget by mid-January, with markets looking for 10 trillion yen in new spending, part of which would need to be covered by new borrowing.
So far there is little evidence that the latest retreat in the yen, a boon for struggling exporters, and a rise in stocks, have began dispelling entrenched pessimism of Japanese businesses and consumers.
The central bank's Tankan survey published just before the December 16 election that swept Abe's party back to power showed business mood soured in the current quarter and companies remained pessimistic about the next three months.
In addition, 15 years of falling wages have discouraged consumers from spending, reinforcing a deflationary spiral, and it remains to be seen if or when additional government spending and the BOJ's monetary stimulus will change that.
In the longer run, economists want to see other ideas from the new government to sustain growth after the initial shot in the arm.
"The policy mix that Abe is pushing for could close the output gap temporarily," said Shuji Tonouchi, senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities.
"It's possible for prices to rise approaching fiscal 2014, but once the public works spending stops, the output gap will widen again and prices will fall. We cannot rely on public works spending forever."
While many economists say a spending splurge may give Japan a temporary boost, the harshest critics of Abe's prescription, dubbed by media as "Abenomics", say it is plain wrong.
"For two decades, Japan has acted as if fiscal "stimulus" must eventually work, running up the biggest peacetime debt in history at over twice the size of annual output," said Derek Scissors, a research fellow at The Heritage Foundation, a Washington-based conservative think-tank.
"The result? Japanese GDP in 2011 was no larger than in 1992. Mr. Abe wants to do more of the same, and he will receive more of the same in return."
The proposed remedies are free trade deals that would give Japanese exporters better access to major markets but also boost competition at home, deregulation, incentives for home-grown entrepreneurs and family-friendly policies to bring more women into the workforce.
In the meantime, relief for the world's third-largest economy should come from an expected improvement in global economic conditions, the monthly report said, allowing Japan to pull out of a brief and shallow recession and start growing again early in 2013.
But it warned that lingering uncertainty over the U.S. "fiscal cliff" budget crisis, the euro zone debt problems and a slowdown in China remained major risks.
($1 = 84.3900 Japanese yen)
(Writing by Tomasz Janowski; Editing by Alex Richardson)