By Leika Kihara
TOKYO (Reuters) - Japan's economy shrank less than expected in the second quarter although capital expenditure fell more than originally forecast, revised data showed, keeping policymakers under pressure to do more to energize the fragile recovery.
Analysts expect any rebound in July-September growth to be feeble as factory output unexpectedly fell in July and China's slowdown dampened prospects for a solid recovery in exports.
"Factory output lacks strength in July-September due to sluggish exports of cars and electric machinery," said Junichi Makino, chief economist at SMBC Nikko Securities.
"If consumer spending fails to pick up, the government may compile a supplementary budget" to prop up growth, he said.
The world's third-largest economy shrank an annualized 1.2 percent in April-June, less than the initial estimate of a 1.6 percent contraction, Cabinet Office data showed on Tuesday.
The median market forecast was a revision to a 1.8 percent contraction.
Capital expenditure fell 0.9 percent from the previous quarter, more than a preliminary 0.1 percent drop, clouding the outlook for the world's third-largest economy.
But the weakness in capital spending was offset by gains in inventories, which contribute to economic growth.
Inventory gains added 0.3 percentage point to growth, more than a preliminary 0.1 percent contribution, the data showed.
Japanese policymakers are clinging to the hope that companies will use the record profits they earned from a weak yen and lower energy costs to boost wages and investment, generating a positive cycle of rising income and higher spending.
But a recent batch of soft data has cast doubt on such optimism and the Bank of Japan's argument that a steady recovery will help accelerate inflation to its 2 percent target by around September next year.
The BOJ is expected to offer a bleaker assessment on overseas economies at this month's rate review, sources say, although many in the bank prefer to hold off on expanding stimulus for now.
(Reporting by Leika Kihara; Editing by Shri Navaratnam and Eric Meijer)