The slump in production is likely to intensify debate on the need for Abe’s administration to increase spending and for Bank of Japan Governor Haruhiko Kuroda to boost already unprecedented monetary stimulus from the BOJ.

Falling prices and weak consumer spending at home, combined with a slowdown in China that’s reverberating globally, are weighing on Japanese businesses. They’re holding back investment as inventories pile up in warehouses at a time when Abe wants them to ratchet up wages and funnel cash into new capital equipment.

“The economic recovery has ground to a halt,” said Marcel Thieliant, a Singapore-based economist for Capital Economics. Thieliant, along with economists at Mizuho Securities, SMBC Nikko Securities and Nomura Securities all flagged the risk that gross domestic product for the quarter ending today may have contracted.

Retail Sales

Production dropped 0.5 in August from July, when it slid 0.8 percent, the trade ministry said on Wednesday. Economists had projected a 1 percent gain while the government had estimated a 2.8 percent expansion. Retail sales data also showed weakness, with no improvement in August from a month ago.

The yen, which has been driven lower by more than two years of stimulus from the Bank of Japan, weakened 0.1 percent to 119.85 per dollar at 11:43 a.m. in Tokyo. The Topix stock index bounced back from two losses earlier this week to advance 2 percent at the end of morning trading.

Today’s data is a bitter pill for Abe, who is returning his attention to the economy after focusing on the passage of unpopular defense bills in recent months. Last week he unveiled a new economic growth target and and vowed to halt Japan’s population slide.

Before the release of Wednesday’s data, economists at BNP Paribas SA and Deutsche Bank AG were outliers among economists projecting falling GDP.

Further Easing

“We have to look into the possibility of a third-quarter contraction,” said Masaki Kuwahara, an economist at Nomura in Tokyo. “Policymakers will consider an extra budget and further monetary easing.”

The government should assemble a spending package to shore up the economy, which could then be followed up by the central bank cranking up its stimulus, Heizo Takenaka, an adviser to Abe, said on Tuesday.

Inventories rose 0.4 percent in August from July, and expanded in five of eight months this year. As stockpiles of unsold goods mount, companies are less likely to expand output in the future.

Production declined in 10 out of 15 industries included in the data, including general purpose machinery and electronics.

Attention turns next to the BOJ’s Tankan survey: a measure of business confidence and intentions due Thursday.

Any weakness would increase pressure for the BOJ to adjust policy at an Oct. 30 board meeting, said Kuwahara. The most recent survey of economists on this question had about a third of them expecting a change by the central bank next month.