By Makiko Yamazaki and Chang-Ran Kim
TOKYO, Feb 16 (Reuters) - Japan's economy limped back to meagre growth in the fourth quarter, significantly missing market expectations in a key test for Prime Minister Sanae Takaichi's government as cost-of-living pressures drag on confidence and domestic demand.
Fresh off a sweeping election victory, Takaichi's administration is preparing to ramp up investment through targeted public spending in sectors seen as vital to economic security.
Monday's data bring sharp focus to the challenge at hand for policymakers at a time when the Bank of Japan has reiterated its pledge to keep raising interest rates and normalise monetary settings from years of ultra-low borrowing costs.
"It shows that the economy's recovery momentum is not very strong," Meiji Yasuda Research Institute economist Kazutaka Maeda said. "Consumption, capital expenditure and exports - areas we hoped would drive the economy - just haven't been as strong as we expected."
Gross domestic product in the world's fourth-largest economy increased an annualised 0.2% in the October-December quarter, government data showed, well short of a median market estimate of a 1.6% gain in a Reuters poll. It barely scraped back to growth from a larger revised 2.6% contraction in the previous quarter.
The reading translates into a quarterly rise of 0.1%, also weaker than the median estimate of a 0.4% uptick.
Economists project Japan will continue to expand at a gradual pace in coming months, though the fourth quarter's weak outcome suggests the economy might struggle to fire on all cylinders.
"Whether the economy can achieve sustainable growth really depends on whether real wages can firmly return to positive growth," Shinichiro Kobayashi, principal economist at Mitsubishi UFJ Research and Consulting, said. "In that sense, the key will be the outcome of this year's wage negotiations in the coming months."
A survey this month by the Japan Center for Economic Research showed 38 economists forecast an average annualised growth of 1.04% in the first quarter and 1.12% in the second quarter this year.
Kobayashi said the GDP report is unlikely to affect the Bank of Japan's monetary policy decisions. "Rather than this rate hike causing the economy to stall, the BOJ's focus is likely to be on how to contain inflation," he said.
Private consumption, which accounts for more than half of economic output, rose 0.1% in October-December, matching market estimates.
It cooled from the 0.4% rise in the previous quarter, indicating that persistently high food costs remain a drag on household spending.
Capital spending, a key driver of private demand-led growth, also rose at a slow pace of 0.2% in the fourth quarter, versus a rise of 0.8% in the Reuters poll.
Net external demand, or exports minus imports, contributed nothing to growth, versus a 0.3 point drag in the July-September period.
Exports posted a milder drop after the United States formalised a baseline 15% tariff on nearly all Japanese imports, down from 27.5% on autos and initially threatened 25% on most other goods.
"The impact of tariffs appears to have peaked in July-September, but judging from the latest results, there is at least some possibility that firms will continue to take a somewhat cautious stance going forward," Meiji Yasuda's Maeda said.
(Reporting by Makiko Yamazaki and Chang-Ran Kim; Editing by Sam Holmes and Shri Navaratnam)
