TOKYO (Reuters) - Japan’s core machinery orders fell by the most in eight months in a worrying sign that global trade tensions are taking a toll on corporate investment, casting doubt that solid domestic demand can help offset external pressure on the export-reliant economy.

FILE PHOTO: Construction cranes are reflected in mirrors at a company compound in Tokyo, February 12, 2015. REUTERS/Thomas Peter/File Photo

Any downturn in business spending will hurt prospects for stronger wage growth and dampen the central bank’s hopes that a sustained economic recovery will prod firms to boost prices and wages, helping to reach its 2% inflation goal.

Cabinet Office data on Monday showed that core orders, a highly volatile data series regarded as an indicator of capital spending in the next six to nine months, fell 7.8% in May from the previous month.

The reading, the biggest drop since September and down for the first time in four months, compared with a 4.7% decline seen by economists in a Reuters poll and followed April’s 5.2% rise.

Policymakers are counting on domestic demand to offset risks such as the Sino-U.S. trade war and slowing global demand that could threaten to derail the world’s third-largest economy.

Capital expenditure has been a bright spot in the fragile economy, helping first-quarter gross domestic product to expand at an annualized rate of 2.2%.

However, external risks cloud the outlook for Japan, which would weigh on business confidence and could in turn put a drag on capital expenditure.

That could fan concerns about domestic demand just as Prime Minister Shinzo Abe’s government is set to raise the national sales tax to 10% in October.

“Despite a slump in May, machinery orders point to broadly stable capital spending in the second quarter. Even so, we expect investment growth to slow sharply over the coming quarters,” said Marcel Thieliant, senior Japan economist at Capital Economics.

“Resilience is unlikely to last. Firms have revised down their capital spending plans in light of weaker external demand. And consumer spending is set to slow after October’s sales tax hike.”

Underscoring fragile consumer confidence, a Cabinet Office survey showed on Monday that household sentiment fell to a three-year low in June, despite some moves toward frontloading spending ahead of the tax hike.

The survey of people such as taxi drivers, hotel workers and restaurant staff - dubbed “economy watchers” for their proximity to consumer and retail trends - showed the overall mood on current conditions had slipped 0.1 point from May month to 44.0, below the 50 threshold pointing to a steady reading for 18 months.

SALES TAX HIKE

The previous tax hike to 8% from 5% in April 2014 dealt a blow to consumers and triggered a deep economic slump. Since then, Abe has twice delayed a planned further hike.

The Cabinet Office maintained its assessment on machinery orders to say they are showing a pick-up.

By sector, core orders from manufacturers fell 7.4% in May from the previous month, swinging sharply lower from the prior month’s 16.3% gain, while those from the service-sector dropped 9.0%, down for the first time in three month, the Cabinet Office data showed.

The data comes a week after the Bank of Japan’s quarterly tankan survey showed solid Japanese business expenditure plans, with big firms planning to raise their capital expenditure plan by 7.4% in the fiscal year to March 2020.

The BOJ will scrutinize the tankan results and a batch of other indicators at its policy-setting meeting later this month when it issues fresh economic and price projections.

Japan’s capital expenditure has been driven by demand for boosting labor-saving technology to cope with a labor crunch in the fast-ageing population, high-tech investment and upgrading old plant and equipment.