Japan's economy shrank in the second quarter at a faster pace than initially reported as companies held back on capital expenditure due to worries about a rising yen and faltering global growth.

Economists say Japan is likely to resume growing in the third quarter after three consecutive quarters of contraction, boosted by a rapid recovery in supply chains following the March 11 earthquake, but the outlook further ahead looks increasingly in doubt.

Other data pointing to weak business investment and a dip in exports increasingly suggest Japan will not be able to rely much on external demand. This could pressure the government to speed up reconstruction spending and lean on the central bank to weaken the yen by easing policy further.

As capital spending is unlikely to grow as strongly as previously thought, a rebound in GDP in July-September may be smaller than initially thought although gradual recovery is still expected, said Yuichi Kodama, economist at Meiji Yasuda Life Insurance in Tokyo.

There are also increased chances of the yen's appreciation in the coming month due to the Federal Reserve's expected easing and the latest Swiss move. The BOJ may be prompted by market moves, rather than the economy's performance, to ease its policy.

HARSH CONDITIONS

Gross domestic product shrank a revised 0.5 percent in the second quarter, bang in line with the median market forecast and compared with the initially reported 0.3 percent contraction, Cabinet Office data showed on Friday.

On an annualized basis, the economy contracted 2.1 percent, against a 2.2 percent fall expected by economists.

Capital expenditure fell a revised 0.9 percent, compared with an initially reported 0.2 percent rise and a 1.9 percent fall expected by economists.

Private inventories contributed 0.1 percentage point to GDP, less than a 0.3 percentage point contribution in preliminary data as parts shortages eased for some firms, allowing companies to finish partially manufactured goods, a government official said.

In another encouraging sign, government consumption and investment made a slightly positive contribution to GDP due to spending and investment in tsunami-hit areas on temporary housing and other items, the official said.

From July, supply chains have recovered and the government has judged that the economy is picking up, Economics Minister Motohisa Furukawa told reporters.

But given worries about global economic risks and fluctuations in the foreign exchange and stock markets, the environment surrounding the Japanese economy is increasingly severe.

Separate data showed Japanese consumer confidence was steady in August after rising in the previous three months, suggesting the post-quake rebound in sentiment may have ground to a halt.

The revised GDP data follows a Ministry of Finance survey released last week that showed capital expenditure unexpectedly fell in the second quarter from a year earlier due to waning global demand.

While economists expect Japan to exit recession triggered by the March 11 earthquake and tsunami, some have started questioning whether overseas demand and reconstruction spending will carry the economy further.

The Bank of Japan could come under increased pressure to ease monetary policy in coming months as the yen remains stubbornly high against the dollar, threatening to harm exports.

(Writing by Tomasz Janowski; Editing by Edmund Klamann)

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