Aug 28, 2:15 AM EDT

Japan reports inflation, household spending soften in July


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TOKYO (AP) -- The backdrop to the wild drama in financial markets over the past few weeks is a less dramatic but more daunting reality: the deep-seated challenges for sustaining long-term growth, especially for aging economies like Japan's.

Japan released data Friday showing its economy has yet to escape the doldrums more than two years after Prime Minister Shinzo Abe launched an unprecedented effort to jolt the country out of its deflationary rut.

Core inflation excluding volatile food prices flat-lined at its lowest level in more than two years in July and household spending also slowed, the government reported.

Unemployment edged down to 3.3 percent and household incomes rose 5.4 percent in real terms, thanks largely to semi-annual bonus payments. Such trends are leading economists for forecast the economy will return to expansion after a 1.6 percent contraction in annual terms in April-June.

But the middling vital signs, and worries over China's ability to stoke its own growth, may raise pressure on the Bank of Japan to up its unprecedented barrage of monetary stimulus.

The central bank is spending trillions of yen (billions of dollars) a month on asset purchases intended to push inflation higher and end years of deflation, or chronic price decreases.

The aim is to get consumers and businesses to spend more money and spur growth, but so far the inflation rate remains far from the official 2 percent target, and the spending that accounts for most of Japan's economic activity has remained lackluster despite modest increases in some workers' wages.

It is unclear if the recent gyrations in share prices will have a spillover effect on spending.

The main Nikkei 225 stock index climbed 2.8 percent on Friday, though it was still down more than 6 percent for the week.

BOJ Gov. Haruhiko Kuroda said in a speech to the Japan Society in New York this week that the bank is keeping a close eye on potential risks and will "make adjustments without hesitation as necessary."

He pointed to rising machinery orders and construction starts - and the first hike in the price of ketchup in Japan in 25 years - as evidence the monetary easing is bearing fruit.

Still, he acknowledged widespread disappointment with Japan's progress so far in revamping its economy to improve its competitiveness as promised by Abe in early 2013.

"In hindsight, it is clear that there has been a lack of incentive and impetus to make change happen," he said.

Kuroda acknowledged concerns over the risks from weakening demand as exports to China and other emerging markets stall.

But he and other Japanese officials insist the economy is still heading for a "moderate recovery." And while households remain frugal, relatively solid retail sales could carry on into a much stronger showing for August, says Masamichi Adachi of JPMorgan.

"A feared continued decline of consumption in this summer looks quite unlikely now," he said in a report Friday.

In the longer term, the outlook is much less certain.

Corporate profits have surged to record levels, in part because a weakening of the Japanese yen means revenues earned overseas buy local currency.

But business investment remains modest since companies are wary of building more capacity in the domestic market when the population is aging and shrinking. So overall productivity remains below the level it was at in 2010, according to the latest data from the Japan Productivity Center.

Bill Adams, an economist with PNC Financial Services Group, notes that lackluster household spending may partly be due to belt-tightening by the growing numbers of Japanese retirees living on fixed incomes.

"The problem is all developed economies and even emerging economies are now aging," says Adachi. "We are not prepared for that."

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