TOKYO (July 11): Japan's core machinery orders unexpectedly fell for a second straight month in May, government data showed on Thursday, stoking worries about capital spending and the sustainable recovery needed for the Bank of Japan (BOJ) to raise interest rates.

The volatile leading indicator of capital spending fell 3.2% month-on-month in May, following a 2.9% drop in April and confounding analysts in a Reuters poll calling for a 0.8% increase.

The decline in machinery orders may be a bad omen for BOJ's plans to normalise monetary policy, as the BOJ has embarked on unwinding its unconventional policy. It raised rates in March for the first time since 2007 and decided in June to cut government debt purchases.

"Given fragile consumer spending and corporate investment, it will be difficult for the BOJ to raise interest rates at its upcoming policy review" scheduled for July 30-31, said Takeshi Minami, chief economist at Norinchukin Research Institute.

The central bank will wait until October to see if conditions are set for further rate hikes, Minami said.

"Japanese firms, particularly those in the service sector, may turn wary about boosting capital spending, while increasing wages and labour-saving investment to cope with a labour crunch."

The Cabinet Office, which compiles the data, cut its view on machinery orders, saying there are signs a pick-up is stalling. It marked the first downgrade in the assessment since the start of this year.

The core orders exclude shipbuilding and repairs, as well as electricity power generation, which tend to be more volatile. Orders from overseas are also not counted as core orders but are categorised as external orders.

Core orders account for around one-third of the overall machinery orders, and external orders make up around 40%. Orders from overseas jumped 9.1% month-on-month in May, and 20.9% from the same month a year earlier.

By sector, manufacturers' orders rose 1.0%, and non-manufacturers fell 7.5%, partly because of the loss of demand in the communications industry for items such as computers, the Cabinet Office data showed. Orders for chipmaking machinery helped to drive up the numbers for manufacturers.

Compared with a year earlier, core orders, regarded as an indicator of capital spending for the coming six- to nine months, increased 10.8% in May.

A Cabinet Office survey showed core orders grew 4.4% in January-March from the previous quarter, but were expected to fall 1.6% in the second quarter.

Capital spending has generally been one of the few bright spots in Japan, due to demand for labour-saving technology to cope with a labour crunch.

The government is aiming for domestic investment, including research and development, to top 100 trillion yen (US$620 billion) by fiscal year 2027.

Gross domestic product (GDP) data showed earlier this month that private non-residential investment fell 0.4% in January-March, making capital spending and consumption the major culprits behind a sharper-than-expected economic contraction.

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