Japan's economy shrank much more-than-expected in the fourth quarter, as Thai floods, a strong yen and weak demand hurt exports, casting doubt on hopes for a quick pick up in activity that could bolster government plans to raise the sales tax.

Prime Minister Yoshihiko Noda needs to persuade a skeptical public that the economy is strong enough to double the sales tax without prolonging the stagnation that has plagued the country for two decades.

But GDP data on Monday showing economic output fell 0.6 percent in the fourth quarter will not help his cause and could translate into increased political pressure on the Bank of Japan to use some of its limited policy firepower to lift the struggling economy.

Policymakers are prone to mount pressure on the BOJ to ease policy further and boost inflation in order to proceed with the sales tax hikes, said Takahide Kiuchi, chief economist at Nomura Securities.

The fourth-quarter drop was twice as big as analysts had forecast and marked the fourth contraction in the last five quarters, ending a year when Japan was also hit by an earthquake, tsunami and the worst nuclear power accident since Chernobyl in 1986.

Economic output for all of 2011 fell 0.9 percent, the first full-year slide since the global financial crisis in 2009. That translated into heavy losses for some of Japan's biggest exporters, including Sony Corp <6758.T>.

This is a contraction driven by external demand. Exports have fallen a lot because of a triple shock from Europe, the strong yen and floods in Thailand, said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management Co in Tokyo.

In addition, domestic demand contributed a mere 0.1 percentage point to GDP in October-December compared with 0.9 percent in the third quarter, a worrying sign that the economic boost from rebuilding the earthquake-devastated northeast coast is slow in coming.

Japan has struggled to sustain economic growth since a property-price bubble burst in the early 1990s, prompting years of deflation that persists to this day and huge government borrowing aimed at sparking fresh life into the economy.

Noda hopes to contain the rise in the debt pile --

now already twice the size of the economy -- by doubling the national 5 percent sales tax by late 2015, but has yet to win over a combative opposition and a skeptical public.

Raising the sales tax has been a political taboo for Japan's politicians for years despite experts suggesting any negative economic impact would be short-lived.

With Europe mired in a debt crisis and the United States losing its gold-plated credit rating, the IMF has warned Japan it risks a sudden loss of market trust if it fails to raise the sale tax.

Although the economy is expected to pick up this year, the debt crisis in the euro area and the persistent strength of the yen cloud the outlook for the economy and the sales tax.

If the economy's weakness persists, it would naturally give politicians incentive to pile up pressure on the BOJ and to put off the sales tax, said Yasuo Yamamoto, a senior economist at Mizuho Research Institute.

If that happened financial markets would react negatively, he said, and Japan's credit ratings could be downgraded further.

The Bank of Japan, which began a two-day meeting on Monday, is unlikely to be pressured into easing policy this week, analysts said. But pressure is rising as the economy hurts from a strong yen, made more attractive to investors by a U.S. central bank committed to keeping its rates low until at least late 2014.

The BOJ cut its policy rate to close to zero in response to the global financial crisis and has since created a 55 trillion yen asset buying and lending program, leaving it with limited firepower now.

I don't expect the BOJ to ease policy anytime soon unless the yen spikes further, said Takahide Kiuchi, chief economist at Nomura Securities.


Japan's economy only recorded one quarter of expansion in 2011. GDP rose a revised 1.7 percent in the third quarter in a rebound from the March 11 earthquake and tsunami that triggered radiation leaks from the Fukushima nuclear power plant.

On an annualized basis, the economy shrank 2.3 percent in the fourth quarter, compared with an annualized expansion of 2.8 percent in the United States. The euro zone economy is expected to report this week that the economy shrank at an annualized rate of around 1.7 percent.

The economy is likely to remain in a soft patch through the first half of this year as exports struggle, capital spending slows and implementation of public works is delayed, said Yoshiki Shinke, senior economist at Dai-ichi Life Research Institute.

Supply-chain disruptions caused by the Thai floods added to the pressure on Japanese companies that were already fighting against a yen that rose to a record high against the dollar. Net exports cut 0.6 percentage points off GDP in October-December.

Honda Motor Co <7267.T> slashed its annual profit guidance in January to the lowest level in three years, blaming the Thai floods and the yen.

TV makers Panasonic <6752.T>, Sony <6758.T> and Sharp <6753.T> forecast a combined loss of $17 billion this fiscal year, partly as a result of floods and the yen.

The yen was trading around 77.70 to the dollar on Monday, comfortably below its record high of less than 76 per dollar, but still above Japanese exporters' comfort levels.

Japan spent a record 8 trillion yen ($103.04 billion) in unilateral intervention on October 31, and another 1 trillion yen in early November on undeclared forays into the currency market.

(Additional reporting by Chris Gallagher and Stanley White; Editing by Tomasz Janowski and Neil Fullick)