By Tetsushi Kajimoto and Izumi Nakagawa
TOKYO (Reuters) - The Japanese government upgraded its assessment of the economy on Monday, as emerging signs of an upturn in exports and factory output added to growing evidence that Prime Minister Shinzo Abe's aggressive polices are beginning to reignite growth.
The world's third-biggest economy is gradually recovering, according to the government's monthly report released by the Cabinet Office.
The upgrade was the first in two months, and an improvement from April when it said the economy was showing signs of recovery but still had some weak spots.
The government's latest take on the economy came ahead of the Bank of Japan's two-day meeting ending on Wednesday, which is expected to leave policy unchanged after announcing a sweeping monetary expansion campaign in early April to vanquish 15 years of entrenched deflation.
Policymakers are also likely to take heart from a Reuters Tankan survey which showed manufacturers' sentiment rose for a sixth straight month in May, turning positive for the first time in a year.
According to the survey, released earlier on Monday, increasing optimism among manufacturers was largely driven by export sectors, including electric and precision machinery, that have benefited from a sharp weakening in the yen.
"Manufacturers had been lagging the services sector, but a weak yen and improvements in the U.S. economy mean that manufacturers' sentiment is starting to catch up," said Hiroshi Miyazaki, senior economist at Mitsubishi UFJ Morgan Stanley Securities.
"This is in line with the bullish scenario that the BOJ has laid out. There's no need to change policy."
Since Abe unveiled his strategy in November to end two decades of economic stagnation the yen has slumped to 4-1/2 year lows versus the dollar and share prices have rocketed by 70 percent.
Abe is hoping that the wealth-creating effects of a buoyant stock market and expectations for further improvement in the broad economy will generate a virtuous circle of consumption, investment and employment that will ultimately revitalize growth.
"We are implementing fiscal and monetary policies under Abe's administration, and this has set the stage for a V-shaped recovery," said Economics Minister Akira Amari said.
"Normally exports lead growth, but this time consumer spending is playing the leading role," Amari told a news conference after the government released its latest assessment of the economy.
The manufacturers' sentiment index rose by 11 points to plus 7 in the Reuters Tankan for May, the first positive figure since May 2012 and its highest reading since September 2011. It is expected to reach plus 22 in August.
The monthly poll closely correlates with the central bank's key Tankan quarterly company survey.
The poll comes days after government data showed the economy grew a faster-than-expected 0.9 percent in January-March from the previous quarter thanks to a big gain in private consumption and a pick-up in exports.
"A weak yen could have a big impact on our earnings, but its effects have not yet played out much in real demand," one electric machinery maker said in the Reuters survey.
SPIRITS PICK UP AS YEN FALLS
The yen's decline accelerated after the BOJ's April 4 decision to commit to open-ended asset buying to nearly double the monetary base to 270 trillion yen ($2.62 trillion) by the end of 2014 in a shock therapy to achieve 2 percent inflation.
The Reuters Tankan showed the index for service sector firms rose seven points to plus 19 in May, marking its highest reading since October 2007. It is seen reaching plus 28 in August led by sectors including real estate/construction and retailers.
While there are signs of early success for Abe's policies, not everyone is convinced that Japan's economic fortunes have improved.
Some companies complained of a lack of real demand, suggesting that a fully fledged recovery may not take hold for some time, according to the Reuters Tankan.
A precision machinery maker said: "Economic recovery is felt due to a weak yen caused by Abenomics monetary policy. But it has not led orders to recover and the situation remains tough."
Other manufacturers complained that higher import prices were squeezing profits as they struggle to pass on higher costs to their customers.
The government, however, remained optimistic about the outlook for growth.
"We expect the economy to continue to recover as exports improve and as economic stimulus and monetary policy steps bolster sentiment," the Cabinet Office said in its report.
($1 = 102.9750 Japanese yen)
(Editing by Simon Cameron-Moore and Shri Navaratnam)