By Minami Funakoshi
TOKYO (Reuters) - Sentiment in Japan's service sector hit a fresh low in May due to worries about oversupply in the housing market and a return to deflation, giving another worrying signal that Prime Minister Shinzo Abe's strategy to reflate the economy is sputtering.
After returning to power in late 2012, Abe embarked on a three-pronged strategy - dubbed "Abenomics" - of massive monetary easing, fiscal stimulus and structural reforms to break the economy free of years of deflation, but it continues to flit in and out of recession.
The survey of workers such as taxi drivers, hotel workers and restaurant staff - dubbed "economy watchers" for their proximity to consumer and retail trends - showed their confidence dipped 0.5 point to 43.0 from the previous month.
It was the lowest index reading since November 2014, the data, released by the Cabinet Office showed on Wednesday, showed.
One of the biggest reasons for the poorer sentiment was weakness in the housing market, suggesting the Bank of Japan's negative interest rate policy may be distorting some areas of the economy and failing in its mission to raise inflation expectations.
"As a consequence of the negative rate policy, the number of people buying income-generating properties is increasing and land prices are rising, which makes it seem that the real-estate industry is doing well. But the actual economy is not good. Rent isn't rising and the proportion of rooms that are empty remains high - I cannot say the economy is looking up," said a respondent from the real-estate industry.
Sentiment also worsened due to concerns that shoppers' frustration with low wage growth is forcing them to focus spending on bargains.
"Consumers are shopping at stores that offer products that are as cheap as possible, which shows deflationary trends are strong. Consumer mindset remains low and will worsen somewhat in the future," said a respondent from the convenience store industry.
Weak service-sector sentiment is bad news for the BOJ, which has struggled to lift inflation despite its controversial decision in January to lower interest rates into negative territory.
The data also raises the pressure on Abe's government before upper house elections next month and the announcement of an economic stimulus package this autumn.
The outlook index, which indicates the level of confidence in future conditions, rose 1.8 points to 47.3 in May, helped by expectations that conditions will improve as recovery from the earthquakes that devastated southern Japan in April continues, and that households will spend more to cope with a hot summer.
(Editing by Simon Cameron-Moore)