By Leika Kihara
TOKYO (Reuters) - Japan's core machinery orders fell at a record pace in May in a sign that companies are feeling the pain from slowing global demand, but the data is not likely to be alarming enough to nudge the central bank into loosening monetary policy this week.
Core machinery orders, which help to gauge the strength of capital spending, fell 14.8 percent in May, data showed on Monday, much worse than a median forecast for a 3.3 percent drop and the biggest decline since comparable data became available in April 2005.
The government warned against reading too much into the highly volatile data series, saying the drop was exaggerated by seasonal factors and mostly a reaction to the previous month's rise, which was inflated by big, one-off orders from chemical and machinery makers.
But the weaker-than-expected data suggests that any recovery in Japan's economy will be modest as Europe's debt crisis and slowing growth in big markets such as China could make companies less willing to increase capital spending.
"External demand looks weak. A lot of companies have turned cautious about overseas economies," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management in Tokyo.
"The global economy is weaker than we thought."
Weak U.S. payrolls data last week underscored the fragile state of the world's largest economy, while deepening pain from the euro-zone debt crisis drove the European Central Bank to cut interest rates and the Bank of England to expand its quantitative easing program.
China, the main driver of world growth, also surprised markets with a rate cut last week and will publish second-quarter GDP data this week that is widely expected to be the worst in at least three years.
The Bank of Japan, however, is expected to hold off on easing monetary policy at its two-day meeting that ends on Thursday, convinced that its stimulus steps in February and April are enough to keep the Japanese economy afloat for now.
While many Japanese central bankers are worried about the outlook, they do not see enough evidence that Japan's recovery is under severe threat and thus prefer to save their limited options especially with the yen off its record highs.
"Public spending and personal consumption are driving the Japanese economy but economic growth is likely to slow after the summer, partly as government subsidies for low-emission cars run out of money," said Yasuo Yamamoto, senior economist at Mizuho Research Institute in Tokyo.
"The BOJ is likely to sit tight this week given the current yen movements, but it could ease policy further as early as September if it becomes clearer that the economy is slowing."
Japan's economy is expected to outperform most of its G7 peers this year with growth around 2 percent, as solid private consumption and spending to rebuild from last year's earthquake offset slowing global demand.
The BOJ upgraded its assessment for all nine regions of the economy last week, while its closely watched tankan quarterly survey for June showed big manufacturers' sentiment improved for the first time in three quarters and companies planned increases in capital expenditure.
But machinery orders in May fell for both manufacturers and service sector firms, suggesting that corporate investment may not turn out as strong as the tankan survey suggested.
Big Japanese consumer electronics makers, for one, are in no mood to boost capital spending as they confront the global slowdown and stiff price competition.
Sony Corp <6758.T> plans to cut capital spending by 29 percent in the year to March 2013 and Panasonic Corp <6752.T> by 27 percent, after incurring huge losses in their TV manufacturing businesses.
Automakers, whose sales grew for 10 months in a row to June on tax incentives for purchases of fuel-efficient cars, are also cautious about the outlook as money set aside for the program is expected to run out in the next month or two.
They have boosted factory output to meet strong demand but are looking to export more from their North American operations instead of shipping vehicles from Japan, where a strong yen undermines profits.
Toyota Motor <7203.T> has said it wants to reduce its exports out of Japan, now around 1.7 million vehicles a year, to 1.5 million to escape currency losses.
Rising energy costs also continued to undercut Japan's ability to earn money from abroad. Separate data showed Japan's current account surplus slumped by 62.6 percent in May from the same period a year earlier, faster than the median estimate for a 14.5 percent decline, due to rising energy imports.
(Additional reporting by Kaori Kaneko, Tim Kelly and Yoko Kubota; Editing by Edmund Klamann)