By Leika Kihara and Tetsushi Kajimoto
TOKYO (Reuters) - Japan's first quarter growth handily beat initial estimates on an unexpected surge in capital spending, fresh signs the world's third-biggest economy is in better shape to weather a hit to consumption from a sales tax hike.
Capital spending, long a weak link in the economy, is a key focus in Tokyo's campaign to engineer a revival after two decades of sub-par growth and grinding deflation.
"Companies don't tend to ramp up spending ahead of the sales tax hike, so the increase likely reflects improvements in corporate profits and diminishing slack," said Mitsumaru Kumagai, chief economist at Daiwa Institute of Research.
Japan's economy grew an annualized 6.7 percent in the first quarter, data showed on Monday, up sharply from an initial reading of a 5.9 percent rise, and confirmed the fastest pace of growth since July-September 2011. The data beat the median market forecast for GDP to rise 5.6 percent.
The upward revision was largely due to a recalculation in capital expenditure that took into account finance ministry data showing a solid increase in spending.
Adding to the optimism, current account data showed foreign visitors spent more money than Japanese traveling abroad for the first time in 44 years, boding well for Japanese companies in the retail and tourism industry.
In other encouraging news, Japanese consumer confidence rose for the first time in six months in May, further underscoring recent signs that the economic pain from the sales tax hike would be temporary. The service-sector sentiment index also edged up.
The tax, which was raised to 8 percent from 5 percent on April 1 to fix Japan's tattered finances, has caused distortions in data and raised worries about the outlook.
Monday's positive figures, however, back the Bank of Japan's view the economy will recover moderately led by domestic demand, with growing evidence of an uptick in business investment a particularly pleasing result for policy makers.
In comments to Parliament, BOJ Deputy Governor Kikuo Iwata sounded suitably upbeat, saying that he expects Japan's exports to turn up as advanced nations recover.
"The Japanese economy will continue growth above its potential rate as a trend as exports turn up and domestic demand remains firm," Iwata told parliament, adding that the economy is on a steady track to meet the BOJ's 2 percent inflation target.
Corporate capital spending rose 7.6 percent, up from a preliminary 4.9 percent increase, an encouraging sign for Prime Minister Shinzo Abe who is keen for companies to spend more of their cash piles to drive a sustainable economic recovery.
On a quarterly basis, the economy grew 1.6 percent in January-March, up from a preliminary 1.5 percent expansion. It compared with a median market forecast for a 1.4 percent rise.
Some analysts warn of uncertainty ahead as companies start to feel the pinch from an increase in the sales tax to 8 percent from 5 percent in April.
"A surge in domestic demand helped Japan achieve high growth in January-March. But a reactionary slump is inevitable, which means the economy will contract in April-June," said Takeshi Minami, chief economist at Norinchukin Research Institute.
Moreover, analysts say weak factory output and household spending falling at the fastest pace in three years in April point to the tax hike's chilling effect on consumer spending.
Still, there are signs the economy will overcome the temporary dips in growth.
Under its "qualitative and quantitative easing" program launched in April last year, the BOJ has been aggressively pumping money into markets on hope that banks will lend more to companies, which will then boost wages and capital spending.
Bank lending rose 2.3 percent in May from a year earlier, increasing for the 31st straight month and growing at a faster pace than 2.1 percent in April, BOJ data showed on Monday.
There was little market reaction to the GDP data.
"The market is more focused on data pertaining to inflation and its possible impact on the Bank of Japan's monetary policy," said Shinichiro Kadota, chief Japan FX strategist at Barclays in Tokyo.
The BOJ has said Japan can weather the tax hike impact and resume a moderate recovery in July-September as exports - now a soft spot in the economy - gradually pick up.
Reflecting the continued weakness in exports, Japan posted its biggest trade deficit for the month of April, leading to a smaller-than-expected current account surplus, Ministry of Finance data showed on Monday.
But the current account data also showed that the travel balance swung to a surplus for the first time since 1970 as foreign visitors outnumbered Japanese traveling abroad.
(Editing by Chris Gallagher & Shri Navaratnam)