More volatility is expected around the health of the world's third biggest economy, as Tokyo raises its sales tax rate and tests growth policies known as Abenomics.

Japan's sales tax rate will increase from 5 to 8 per cent on Tuesday to pay for surging welfare costs.

Analysts and economists expect the hike to cause turbulence on financial markets in coming months.

Consumption plummeted in 1997 when Japan last raised its sales tax, from 3 to 5 per cent, contributed to an 18-month long recession.

Although analysts expect the latest hike to temporarily dent growth, it should not derail the economic recovery of Australia's second biggest trading partner.

Martin Whetton, a Sydney-based strategist at Japan's biggest securities trader Nomura, said while short-term volatility was expected, the medium-term outlook was positive and Prime Minister Shinzo Abe's growth polices, known as Abenomics will work.

Mr Whetton said much of the uncertainty surround the tax hike had been priced into the market, with the Nikkei among the worst performing stock indexes in the world this year.

''I'd suggest that it has to with this disappointment that the recovery in the economy had not been as buoyant as people had thought and the slowing of Chinese growth is also weighing on Japanese exports and overall demand in Japan,'' Mr Whetton said.

Japan's factory output fell unexpectedly in February, shedding 2.3 per cent compared with forecasts of a 0.3 per cent rise and a 3.8 per cent gain in January.

Analysts said the benefits of a last minute surge in demand before the sale tax increase appeared to have ended.

Mr Whetton expected more weak economic data in coming months.

''In the near-term you could expect some volatility around economic numbers, and you run the risk to things being a little bit disappointing. In the medium term we're pretty positive on where it does go and the policies will work.''

And the success of which was vital for Australia, Mr Whetton said.

''Japan, critically for Australia, is our second biggest trading partner. We need them to do well. Not just want, but need.

''It is the third largest economy in the world and, in some ways, it gets forgotten from time to time when people just think of the US and China and the eurozone.''

Nomura has forecast at best average annual growth for Japan to be just under 2 per cent from 2016 to 2020. If Mr Abe's policies fail, Nomura expects about 1 per cent growth.

''In both cases, we think Japan will maintain a current account surplus,'' research analyst Tomo Kinoshita said in a note to investors.

''Under both scenarios, we think deflation will ended as a tight labour market leads to increases in wages.''

Japan's unemployment rate fell to 3.6 per cent in February, its lowest since 1997.

Guy Bruten, Alliance Bernstein's Asia Pacific economist, said the labour market figures was a better way to assess the health of Japan's economy rather than ''noisy activity data''.

Still, he said the tax hike injected a ''large amount of uncertainty into Japan's economic picture''.

''We continue to argue that the backdrop is very different from 1997 [in the lead up to last tax increase], and that the impact should be materially smaller.

''But, in any event, it's not going to be clear what the true underlying pulse of the economy is until we get well into the back half of the year.''