By Leika Kihara and Tetsushi Kajimoto

TOKYO Japanese business sentiment improved in the second quarter as easing supply constraints and the removal of pandemic curbs lifted factory output and consumption, a central bank survey showed, a sign the economy was on course for a steady recovery.

Companies expect to increase capital expenditure and project inflation to stay above the Bank of Japan's 2% target five years ahead, the quarterly "tankan" showed, offering policymakers hope that conditions for phasing out their massive monetary stimulus may be gradually falling into place.

The headline index measuring big manufacturers' mood stood at plus 5 in June, bouncing back from a two-year low of plus 1 hit in March in a sign firms were recovering from the hit from rising raw material costs and supply disruptions. The reading, which compared with a median market forecast for plus 3, was the highest since December 2022.

The sentiment index for big non-manufacturers improved to plus 23 in June from plus 22 three months ago, increasing for the fifth straight quarter and hitting the highest level since June 2019, the survey showed on Monday.

Large firms plan to ramp up capital expenditure by 13.4% in the current fiscal year ending in March 2024, exceeding the 3.2% increase projected in the March survey. The increase compared with a median market forecast for a 10.1% rise.

Japan's economy grew an annualised 2.7% in the first quarter and analysts expect it to continue expanding, as a post-pandemic pickup in domestic spending offset headwinds to exports from slowing global growth.

BOJ Governor Kazuo Ueda has repeatedly stressed the need to keep monetary policy ultra-loose until inflation can sustainably hit the bank's 2% target accompanied by solid wage growth.

(Reporting by Leika Kihara and Tetsushi Kajimoto; Editing by Shri Navaratnam)