Japan’s economy shrank at the fastest pace in almost six years in the December quarter as last year’s sales tax hike hit consumer and business spending, highlighting a fragile outlook made worse by growing coronavirus risks.

Analysts say the widening fallout from the epidemic, which is damaging output and tourism, could undermine growth in the current quarter and push Japan into recession - defined as two straight quarters of decline.

“There’s a pretty good chance the economy will suffer another contraction in January-March. The virus will mainly hit inbound tourism and exports, but could also weigh on domestic consumption quite a lot,” said Taro Saito, executive research fellow at NLI Research Institute.

“If this epidemic is not contained by the time of the Tokyo Olympic Games, the damage to the economy will be huge,” he said.

Japan’s gross domestic product (GDP) shrank an annualized 6.3% in the October-December period, government data showed on Monday, much faster than a median market forecast for a 3.7% drop and the first decline in five quarters.

It was the biggest fall since the second quarter of 2014, when consumption took a hit from a sales tax hike in April of that year.

The latest sales tax hike in October last year - as well as unusually warm weather that hurt sales of winter items - weighed on private consumption, which sank a bigger-than-expected 2.9%, marking the first drop in five quarters.

Capital expenditure fell 3.7% in the fourth quarter, much faster than a median forecast for a 1.6% drop and the first decline in three quarters, the data showed.

Combined, domestic demand knocked 2.1 percentage points off GDP growth, more than offsetting a 0.5 point contribution from external demand.

The weakness in capital expenditure - considered among the few bright spots in the economy - casts doubt on the Bank of Japan’s view that growth will continue to expand moderately as robust domestic demand makes up for weakness in exports.

Economy Minister Yasutoshi Nishimura said the government was ready to take all necessary steps and was watching the impact the coronavirus outbreak could have on the economy and specifically tourism.

“The government had hoped Japan’s economy would continue a moderate recovery. But we must be vigilant against the impact of the coronavirus on domestic and overseas economies,” he said in a statement issued after the GDP’s release.

Still, many analysts doubt whether the government and the central bank have effective means to fight another recession given their dwindling policy ammunition.

“The government has already taken steps to respond to the sales tax hike and post-Olympics slowdown, so you cannot expect further steps on the fiscal front,” said Takeshi Minami, chief economist at Norinchukin Research Institute.

“There’s not a lot more the BOJ can do either ... Additional easing may do more harm than good to the economy,” he said.

Japanese policymakers had warned that the economy will suffer a contraction in October-December as the sales tax hike, typhoons and the Sino-U.S. trade war hurt consumption and factory output.

Worries about the spread of the coronavirus and its hit to the global economy kept Japanese manufacturers’ mood gloomy in February, a Reuters poll found.

Investors are now watching to see if growth will rebound in the current quarter as the Bank of Japan projects, amid fresh risks from the coronavirus that have forced factories in China to shut down and led to a sharp drop in Chinese tourists.

The BOJ kept monetary policy steady last month and nudged up its economic growth forecasts on hopes that global growth will rebound around mid-year due to receding risks.

Source: Reuters