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TOKYO (Reuters) - Japan's factory output accelerated in April and deflation abated a bit as a weaker yen and firmer overseas demand boosted growth, boding well for Prime Minister Shinzo Abe's efforts to shake the world's third-largest economy out of nearly two decades of falling prices and sluggish growth.
But core consumer prices continued to fall and manufacturers forecast further weakness ahead, government data showed on Friday, underscoring the challenges the Bank of Japan, under new Governor Haruhiko Kuroda, faces in meeting its 2-percent inflation target.
"The deflationary trend shows no signs of changing," said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance in Tokyo. He forecast the economy will continue to recover through the latter part of the fiscal year to March 2014.
"Expectations for deflation, deeply embedded among the public, are very persistent," Kodama said. "It appears quite difficult for monetary easing implemented by Governor Kuroda to achieve a positive cycle of inflation and economic recovery."
Still, tentative signs are growing that Abe and the BOJ may be starting to win the battle against deflation.
Tokyo prices turned higher for the first time in more than four years. And Apple Inc (AAPL.O) raised the prices of iPads and iPods in Japan on Friday, following the likes of luxury jewelry maker Tiffany & Co (TIF.N), German appliance maker Miele and Volkswagen AG (VOWG_p.DE) in raising prices as a result of the weaker yen.
Kuroda's BOJ unleashed the world's most intense burst of stimulus in April, promising to inject $1.4 trillion into the economy in less than two years to halt the yen's rise and generate inflation of 2 percent.
The move has bolstered Japanese share prices to five-year highs. But the massive scale of the BOJ's buying jolted bond markets and pushed up yields, casting doubt on the effectiveness of its policy aimed at slashing borrowing costs.
Core consumer prices, which include oil but exclude volatile costs for fresh food, fell 0.4 percent from a year earlier, matching the median market forecast. The sixth straight fall was a bit narrower than the 0.5 percent decline in March.
Industrial output rose 1.7 percent in April from March for a fifth consecutive increase, the Ministry of Economy, Trade and Industry said, as a pick-up in exports prompts companies to increase production. It marked the longest streak of gains since production rose between March 2009 and April 2010.
The rise beat the market forecast for a 0.6 percent increase and was faster than the 0.9 percent rise in March. Still, in a sign that the gains remain fragile, manufacturers surveyed by the ministry forecast production to be flat in May and fall 1.4 percent in June.
Private data showed that manufacturing expanded in May at the fastest pace in almost a year.
The Markit/JMMA Japan Manufacturing Purchasing Managers Index rose to a seasonally adjusted 51.5, the highest since August, from 51.1 in April, staying above the 50 threshold that separates expansion from contraction for a third month.
One surprise from Friday's data was that Tokyo core CPI rose 0.1 percent, turning positive for the first time since March 2009. Some economists said the rise was temporary but some said it portends an earlier end to national deflation than previously thought.
SMBC Nikko Securities and Dai-ichi Life Research Institute both moved forward their forecasts for an end to national price declines to May from June.
But Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management, said nationwide CPI is not turning higher fast enough to meet the BOJ's target of 2-percent inflation in two years.
"The economic recovery remains on track, as shown by industrial production, but speculation is likely to increase in the autumn that the BOJ will have to ease policy further," Muto said.
The International Monetary Fund thinks "that the Bank of Japan stands a chance of achieving this goal," said David Lipton, the IMF's first deputy managing director.
"We would not be sure whether it would come a little earlier, on time, or a little later than the goal that has been set," Lipton told a Tokyo seminar.
"But we think that with forceful implementation of the policy, backed up by the other arrows of Abenomics, the country stands for the first time in a very long time a chance of overcoming deflation and meeting the target."
Japan's economy grew a faster-than-expected 0.9 percent in January-March from the previous quarter, as private consumption and the export rebound led a recovery from a slump last year.
Economists expect the recovery to firm up in the coming quarters backed by exports and private consumption. But risks to the outlook remain, including uncertainty in the global economy, underlined recently by a string of weak data from the United States and China, Japan's two biggest export markets.
"Abenomics," which has caused Tokyo shares to soar in recent months and the yen to fall sharply, appears to be showing early success. But the gains have been cast into doubt in the past few weeks as the bond market has become volatile and Tokyo shares have slumped sharply.
The government is under pressure to build on the improved sentiment by undertaking painful structural reforms, such as deregulation, to foster more sustainable growth.
Additional reporting by Kaori Kaneko, Mari Saito and Stanley White; Writing by William Mallard; Editing by Shri Navaratnam and Sanjeev Miglani