Japan's economy rebounded as expected in the third quarter from a recession triggered by a devastating March earthquake on robust exports and consumption, but persistent yen strength and sluggish global growth cloud its outlook.
Companies' efforts to restore supply chains wrecked by the massive earthquake and tsunami and bring back output and exports to pre-disaster levels helped Japan grow at the fastest rate among major industrial nations in the past quarter.
Gross domestic product grew 1.5 percent in July-September from the previous quarter following three quarters of contraction, matching the median estimate by economists.
On an annualised basis, the economy expanded 6.0 percent against a forecast of a 6.1 percent rise.
Yet with that bounce tailing off and demand for Japanese goods dampened by slowing growth in its key export markets, the onus is now on public spending in the nation's biggest rebuilding effort since World War Two to sustain the recovery.
A 12.1 trillion yen ($157 billion) supplementary budget is now in parliament and the government hopes it will be passed by the end of this month.
Japanese policymakers worry the yen's rise driven by safe-haven demand on doubts about Europe's ability to contain its debt crisis could stall export growth and damage the economy before reconstruction spending picks up.
Economists polled by Reuters earlier this month saw growth slowing to 0.5 percent this quarter, with some saying the economy may shrink again as floods in Thailand -- a major production base for Japanese manufacturers -- and cooling of emerging economies add to its woes.
Growth in the fourth quarter is likely to slow partly due to the flooding in Thailand, said Yasuo Yamamoto, senior economist at Mizuho Research Institute in Tokyo.
Looking further ahead, public works spending is likely to start rising as reconstruction work gathers pace and this will contribute to GDP. However, external demand isn't likely to contribute much to Japan's growth in the future due to Europe's problems.
Net exports contributed 0.4 percentage point to GDP growth, the first positive contribution in five quarters, thanks to companies' quick efforts to mend supply chains and factories damaged by the March earthquake and tsunami.
Private consumption, which makes up about 60 percent of the economy, grew a stronger-than-expected 1.0 percent, while corporate capital spending was up 1.1 percent in line with forecast.
Japanese authorities sold an estimated record 7.7 trillion yen ($100 billion) after it set a series of record highs against the dollar in late October and the Bank of Japan eased monetary policy last month but those steps have had only a short-lived impact.
The central bank meets again on November 15-16 and is expected to pause this time, saving up its increasingly limited policy arsenal in case Europe's debt crisis turned into a global shock similar to that sparked by Lehman Brothers' collapse in 2008.
Some people think the BOJ can weaken the yen with aggressive monetary easing, but I think this is a dream. It didn't happen when the BOJ did it before, so I see no reason why it would happen now, said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management Co.
A Reuters Tankan survey and machinery orders data last week showed companies were pessimistic about the outlook, although markets still expect the economy to get a leg up from reconstruction-related demand.
(Additional reporting by Stanley White, Kaori Kaneko and Lisa Twaronite; Writing by Tomasz Janowski; Editing by Edwina Gibbs)