Japan’s exports grew unexpectedly in May on robust car sales, though the rate of expansion slowed to a crawl as inflation and rising interest rates bit into global demand, highlighting a patchy recovery in the world’s third-largest economy.

While the country’s hotels, restaurants and other service sector companies have seen a boom in business since COVID curbs were eased, its factories have been struggling amid weakening demand for cyclical items such as chip-making machines.

Ministry of Finance data showed on Thursday that exports rose 0.6 per cent year-on-year in May, for the 27th straight month of rises, led by 66% growth in car shipments.

The overall exports growth was the slowest since February 2021, but the outcome beat a 0.8 per cent year-on-year decrease expected by 16 economists in a Reuters poll, and followed a 2.6 per cent rise in April.

“Semi-conductor equipment and related exports were the main sources of export weakness, which chimes with the sharp drop in exports to countries like Taiwan and South Korea...offset by continued strength in motor vehicle exports,” said Darren Tay, Japan economist at Capital Economics.

This year, domestic demand may temporarily outpace slumping exports as a key driver of growth, said Takeshi Minami, chief economist at Norinchukin Research Institute.

Separate government machinery orders data, also released Thursday, underlined the struggles faced by manufacturers though the overall numbers suggested the services sector is providing some cushion to the economy.

Core machinery orders rose 5.5 per cent in April from the previous month, the first increase in three months and above the median forecast for a 3.0 per cent gain. While orders from manufacturers were down 3.0 per cent, an 11.0. per cent growth in service-sector demand for items such as computers drove up the headline figure.

On a year-on-year basis, core orders, a highly volatile data series regarded as a leading indicator of capital spending in the coming six to nine months, fell 5.9 per cent, versus a forecast for a decline of 8.0 per cent, the Cabinet Office data showed.

IMPORTS STILL WEAK: The data will be among other key indicators to be scrutinised by the Bank of Japan as it holds two-day policy setting meeting that ends on Friday.

Japan’s gross domestic product (GDP) expanded an annualised 2.7 per cent in January-March, much higher than a preliminary estimate of a 1.6 per cent growth, as revised capital expenditures and firm private consumption more than offset the slowdown in external demand.

The trade data also showed imports fell 9.9 per cent in the year to April, down for the second straight month on softening commodity prices, versus the median estimate for a 10.3 per cent decrease.

The trade balance came to a deficit of 1.3725 trillion yen ($9.80 billion), versus the median estimate for a 1.3319 trillion yen shortfall.

By region, Japanese exports to China, the country’s largest trading partner, fell 3.4 per cent year-on-year in May for their sixth month of decrease, due to shrinking steel and auto parts shipment, although items such as cars and semiconductors recorded growth.

US-bound exports, another key market for Japanese exports, grew 9.4 per cent in the year to May on double-digit gain in car shipment.

“For the outlook of Japanese exports, the US Fed’s rate-hike pause is a positive news that will further vitalise American private consumption”, said Kazuma Kishikawa, economist at Daiwa Institute of Research.

“With recovery in Chinese goods spending and easing supply bottlenecks for Japanese manufacturers, Japan’s export volume will gradually pick up.”

Meanwhile Japanese Prime Minister Fumio Kishida’s administration will pledge to boost childcare spending and focus on sustaining wage hikes in its mid-year economic policy roadmap, a final draft seen by Reuters showed on Thursday.

The blueprint, expected to be approved by cabinet on Friday, comes amid speculation Kishida could dissolve parliament and call a snap election later this year.

Kishida told reporters on Thursday he was not thinking of dissolving parliament during the current Diet session that closes this month, ending weeks of speculation he could do so as early as Friday.

The roadmap will also say the government will use non-tax revenues to fund an increase in defence spending, so that tax hikes could wait until “2025 or later”, the draft showed. That would be later than Kishida’s initial plan to raise taxes in 2024.

On Kishida’s flagship policy to increase Japan’s declining birth rate, the blueprint will pledge to expand payouts to families with children and increase subsidies for medical costs in the next three years, the draft showed.

The blueprint, however, will make no mention of how the spending measures will be funded, saying only the government will reach the decision after “taking a closer look at what specific measures would be taken”, according to the draft.