TOKYO (Reuters) - Japan’s economy shrank more than initially estimated in the fourth quarter - by the most since the 2014 sales tax hike - exacerbating economic fears at a time when the impact of the coronavirus outbreak is increasing recession risks.

FILE PHOTO: High-rise buildings are seen during sunset in Tokyo, Japan, March 7, 2017. REUTERS/Toru Hanai

A spike in the yen and drop in Tokyo stocks - against a backdrop of oil price cuts that are playing havoc with financial markets - add to woes for an economy which is contending with an October sales tax hike to 10% from 8%, as well as slumping tourism and supply chain disruption caused by the health crisis.

The bleak data piles renewed pressure on the government and central bank to deploy stronger fiscal and monetary support.

“Japan’s economy is already in recession and there are emerging signals that the worst has yet to come,” said Mizuho Securities senior market economist Toru Suehiro.

“There’s not much the Bank of Japan (BOJ) can do as monetary easing cannot cure the disease. The least the government and the BOJ can do is to prevent the negative psychological effects of the epidemic from spiralling further.”

The world’s third-largest economy shrank an annualized 7.1% in the three months through December, revised data showed on Monday, more than a preliminary reading of 6.3% and a median market forecast of 6.6%.

The figure represents the steepest decline since April-June 2014, when a sales tax hike to 8% from 5% in April of that year pushed the economy into recession.

The deeper contraction and the virus impact have fueled fears of another decline in January-March to mark two consecutive quarters - the definition of a recession.

“Unfortunately, any recovery in Q1 has been nipped in the bud by the global spread of the coronavirus,” said Capital Economics’ Japan economist Tom Learmouth. The economy is likely to contract 0.5% in the current quarter from the last, he said.

CAPEX WEAKNESS

Analysts largely blamed slower October-December growth on weakness in capital spending - previously considered the lone bright spot in an otherwise weak economy.

Capital spending fell 4.6% from the previous quarter, worse than a preliminary 3.7% estimate and the biggest drop since 2009, in a sign of soft global demand and Sino-U.S. trade war impacting investment appetite.

Private consumption fell 2.8%, in line with the preliminary 2.9% decline, as households withheld spending after the sales tax hike.

The weakness in domestic demand threatens the central bank’s argument that robust capital expenditure will offset some of the pain from soft exports.

The Bank of Japan may take steps next week to ease the financial strain of firms suffering slumping sales due to the virus outbreak.

Adding to the pain for the export-reliant economy, the Nikkei stock average fell 5% to below 20,000 and the yen spiked as investors flocked to the safety of the Japanese currency.

Japan’s finance minister warned on Monday against investors pushing up the yen, saying the government would closely watch market moves which he described as “nervous” amid the global spread of the coronavirus.

If the yen continues to rise, the BOJ may be pressured to take bolder steps beyond financial assistance for small firms, analysts said.

“There were market rumours the BOJ could hold an emergency meeting before its scheduled interest rate review on March 18-19, to ease policy. The trigger could be the Nikkei’s slide below 20,000,” said Dai-ichi Life Research Institute economist Koichi Fujishiro.

“If that happens, the BOJ could ramp up its purchases of exchange-traded funds (ETF) to around 9 trillion to 10 trillion yen” from the current 6 trillion yen ($58.62 billion), he said.

Other data on Monday showed confidence in Japan’s service sector sentiment dropped to its lowest in nine years.

The survey of workers such as taxi drivers, hotel workers and restaurant staff - called “economy watchers” - showed their confidence about current conditions in February at its weakest since April 2011 after the devastating earthquake and tsunami.

The government, for its part, plans to compile a second package of emergency measures to deal with the virus on Tuesday, though analysts said any spending will likely be modest in size and funded by reserves set aside for emergency purposes.

Prime Minister Shinzo Abe has come under fire for his handling of the crisis as the number of coronavirus cases in Japan surpassed 1,100, just as the nation prepares to host the summer Olympic Games in July and August.