Japanese bank shares hammered as US tariffs spur fears about country's fragile recovery

TOKYO (Reuters) -Shares of Japanese banks plunged on Friday as U.S. tariffs sparked fears of a slowdown in global growth that could choke off Japan's fragile economy recovery, snuffing out a decades-long effort to return to normal interest rates.

The Tokyo index of banking stocks ended down more than 8%, bringing its losses this week to 20%. Shares of Mitsubishi UFJ Financial Group, the country's biggest financial firm, dropped 8.5%.

Japanese banks are some of the world's largest lenders by assets, and the sudden slump was a grim reminder of the global impact of U.S. President Donald Trump's protectionist policies and the precariousness of Japan's own exit from deflation.

After years of stop-start growth and frozen wages, the world's fourth-largest economy finally appeared to break through its long malaise last year, as prices - and wages - began to rise. In a hugely symbolic move, the central bank raised interest rates for the first time in almost two decades and its financial markets took off.

Whether that growth trajectory can continue depends to a large extent on what happens in the United States, analysts say. The world's largest economy is the main market for Japanese automakers, the country's economic engine, as well as other industries.

"The world has changed, and few economies reverberate these changes as strongly as in Japan. A weaker dollar, and threats of a global trade recession, put a real dent into Japan’s reflation prospects," said Fred Neumann, Chief Asia Economist at HSBC Hong Kong.

Japan's slow move towards reflation - where prices rise rather than stagnate - has been helped, in part, by the strength of the dollar, which has driven up the cost of fuel, food, and other goods and heaped pressure on companies to raise wages.

Inflation has now exceeded the Bank of Japan's 2% target for almost three years thanks to that stronger dollar and corresponding weakness in the yen currency. That has been a vast change from the 25 years ago, when the BOJ fought to end deflation, keeping rates near zero.

While some analysts believe Trump is open to negotiations on tariffs, investors appear to be factoring in, at least for now, a worst-case scenario.

With fears of a global recession looming, the BOJ is likely to cut its economic growth forecasts and hold off raising rates at its next meeting concluding on May 1, analysts say, predicting the higher duties could knock up to 0.8% off economic growth.

But there is less certainty about just how long the BOJ will be able to keep rates where they are given mounting inflationary pressure at home that has drawn warnings from hawkish members of the board.

    "I think there's the concern that the trade war has killed Japanese reflation - so in short, it's an expression of the slow down in Japan's economy expected to come about because of tariffs, said Kyle Rodda, a senior financial market analyst at Capital.Com in Melbourne.

"Japanese yields have tumbled and the curve has flattened quite a bit, hurting the prospect for bank profits. Add the stronger currency in the air and you have a very negative mix for bank stocks."

(Reporting by David Dolan and Ankur Banerjee; Editing by Edmund Klamann and Kim Coghill)