The Bank of Japan on Tuesday struck a less optimistic tone on its view of the world`s number three economy, although it held off fresh monetary easing measures after its latest policy meeting.
Policymakers flagged housing and industrial production as weak spots, while it said business sentiment had "paused" owing to an April sales tax hike that led to a sharp contraction in second-quarter gross domestic product.
"Japan`s economy has continued to recover moderately as a trend," the BoJ statement said, but it noted "some weakness, particularly on the production side" as demand dived after the rate hike.
Consumer spending has yet to recover fully, but the BoJ said it was still on track to hit a 2.0 percent inflation target, seen as key to reversing years of falling prices and tepid growth.
"Policymakers are slowly but surely acknowledging the recent sluggishness of the economy," said Marcel Thieliant from Capital Economics.
"The bank`s more cautious stance will certainly trigger speculation that additional easing may already be announced at the upcoming meeting at the end of this month."
He said he did not see inflation to pick up towards the end of the year, as the bank expects, but instead decline further.
"With the economic recovery likely to remain subdued, policymakers may therefore have to acknowledge soon that the inflation target remains out of sight," he added.
The dollar fell to 108.61 yen after the announcement, from above the 109 level, while the euro fell to 137.14 yen from 137.64 yen earlier in the day.Despite the slump, BoJ Governor Haruhiko Kuroda has kept up his rosy view of Japan`s prospects, saying Tuesday that factory output would turn around along with corporate and household spending.
"Industrial production data has been showing some weakness...but we`ve been told that the outlook is positive," he told reporters at a post-meeting news briefing.
Kuroda`s upbeat take on the economy has appeared increasingly at odds with the official data, as it suffered in the April-June quarter its deepest contraction since the 2011 quake-tsunami disaster.
Japan`s top central banker has given little indication he will soon increase the BoJ`s asset-purchasing stimulus -- similar to the Federal Reserve`s quantitative easing -- saying the impact of the sales tax hike has not been as bad as expected.
Kuroda also said Tuesday that he was still confident in reaching the inflation target by next year, but added that the bank can adjust its policy if necessary to address "both upside and downside risks" to the economy.
Tokyo`s tax hike was seen as crucial to addressing a mammoth public debt but economists had warned it could derail a budding recovery in an economy beset by years of deflation.
The 1.8 percent dip in gross domestic product -- or a 7.1 percent contraction at an annualised rate -- gave the clearest picture yet of the tax increase`s impact, and threw into question Tokyo`s plans for another such move next year.
Millions of shoppers made a last-minute dash to stores before prices went up on April 1, which was followed by a slump in spending.
Despite its generally positive take on the economy, the BoJ has lowered its growth forecast for the current fiscal year to March to 1.0 percent, well down from a 1.5 percent prediction in late 2013.
