Sept. 28 (Bloomberg) -- Japan's industrial output surged at the fastest pace in almost four years and household spending rebounded, signaling the economy may weather a U.S. slowdown.

Production rose 3.4 percent from July to a record, the Ministry of Economy, Trade and Industry said in Tokyo today. Spending by households climbed 1.6 percent from a year earlier, beating forecasts for a 1.2 percent gain.

Today's numbers ``add some evidence that Japan's economy is becoming more independent from the U.S.,'' said Jan Lambregts, head of Asia research at Rabobank International in Hong Kong. ``The big picture is that there's a lot going on in the world but it doesn't seem to be affecting Japan.''

The reports suggest domestic demand will support expansion in the world's second-largest economy even as global growth slows. The Bank of Japan's Tankan survey of business executives next week is expected to show corporate confidence fell last quarter on concern the U.S. housing recession will curb exports.

The yen rose to 115.26 per dollar at 12:58 p.m. in Tokyo from 115.57 before the figures. The yield on Japan's 10-year bond fell 5 basis points to 1.67 percent after a report showed the pace of new U.S. home sales fell more than forecast.

Spending by households rose even as the jobless rate increased to 3.8 percent in August from a nine-year low of 3.6 percent in July, according to separate data released today.

Third-Quarter Growth

``The spending numbers point to decent consumption growth in the third quarter,'' said Seiji Shiraishi, chief economist at HSBC Securities Japan. ``The monthly labor data is volatile, but basically the job market is solid.''

Finance Minister Fukushiro Nukaga said the employment situation is ``improving'' and the jobless rate probably only worsened because more female workers entered the labor market.

The gain in production, the fastest since September 2003, was led by automakers including Toyota Motor Corp. and Honda Motor Co. as they resumed manufacturing after a July earthquake disrupted output. Export growth unexpectedly accelerated in August, also encouraging manufacturers.

``A strong rebound in production after the earthquake was expected but solid export demand was also a factor,'' said Maiko Noguchi, a senior economist at Daiwa Securities SMBC Co. in Tokyo.

The Tankan survey on Oct. 1 will provide the most up-to- date gauge of corporate sentiment as the housing slump threatens growth in the U.S., Japan's largest overseas market. Sentiment among large manufacturers dropped to 21 points in September from 23 in June, according to the median estimate of 31 economists surveyed by Bloomberg News.

Consumer Prices

Meanwhile, consumer prices excluding fresh food fell 0.1 percent in August from a year earlier, a seventh monthly drop, as retailers absorbed higher costs to attract customers.

Tokyo's core prices, an indicator of the nationwide index, fell 0.1 percent in September, the government said today. Economists expected prices in the capital to be unchanged for a second month.

Daiei Inc. and Aeon Co., among Japan's largest retailers, announced discounts to boost sales even as manufacturers raised the price of products ranging from mayonnaise to toilet paper.

``Unless large retailers start raising prices, Japan's core inflation won't take hold,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. ``The closer companies are to consumers, the harder it is for them to increase prices.''

Retail Sales

Retail sales unexpectedly rose the first time in three months as demand for clothing and autos increased, the Trade Ministry said today. Sales climbed 0.5 percent in August from a year earlier. Domestic sales of passenger vehicles rose for the first time in 26 months in August.

Bank of Japan Governor Toshihiko Fukui said on Sept. 19 that prices will gradually resume rising. Miyako Suda, a central bank board member, said yesterday that consumers' expectations for inflation are increasing.

``As a housewife myself, I've noticed many news reports about price increases in Japan, such as mayonnaise, taxi fares, wine, instant noodles and photocopy paper,'' Suda said. ``There's a risk of inflation soaring unexpectedly in the near future.''

Japan has struggled with deflation since an asset-price bubble burst in the early 1990s, compelling the central bank to cut interest rates to near zero percent.

The Bank of Japan kept the key overnight lending rate at 0.5 percent, the lowest among major economies, last week after the economy contracted in the second quarter and the U.S. Federal Reserve reduced its benchmark rate to avert a recession.

Next Rate Increase

Investors see an 8 percent chance Japan's policy makers will raise the key rate at their next meeting on Oct. 10-11, according to Credit Suisse Group calculations based on interest payments.

Suda said yesterday that the U.S. housing slump ``will have a limited impact on exports'' and the world economy will keep expanding even if U.S. growth slows.

Some economists disagree. Slower global growth will discourage Japanese companies from increasing output in coming months, especially as demand at home has failed to show signs of picking up, said Naoki Iizuka, a senior economist at Mizuho Securities Co. in Tokyo.

``Slower growth in the U.S. is going to hurt exporters and may prompt them to cut back production,'' Iizuka said.

To contact the reporters on this story: Lily Nonomiya in Tokyo at lnonomiya@bloomberg.net; Jason Clenfield in Tokyo at jclenfield@bloomberg.net.

Last Updated: September 28, 2007 00:00 EDT