Japan Q1 GDP slows as corporate spending falls

May 17, 2007 - The Japanese economy expanded at just half the previous quarter's pace in the three months to March as corporate spending fell for the first time in five quarters, possibly putting off any plan by the central bank to raise interest rates in the near term, economists said.

But the decline in capital spending, prompted by decreased output at factories as clients deal with excess inventories, may be a blip, according to economists, and could rebound as demand overseas remains firm.

The Cabinet Office said gross domestic product grew 0.6 pct in real terms in the January-March quarter from the previous three months and at an annualized rate of 2.4 pct. It was the ninth straight quarter of expansion for the world's second-largest economy.

The figures were slightly below market expectations. Ten economists polled by XFN-Asia were looking for quarter-on-quarter expansion of 0.7 pct and annualized growth of 2.6 pct, on average.

In the three months to December, the economy expanded by a revised 1.2 pct from the previous quarter, or at a revised annualized pace of 5.0 pct.

'Today's preliminary GDP data confirmed that Japan's economic recovery remains intact,' said Masayuki Gotoh, senior economist at the Cabinet Office.

For the fiscal year ended March, GDP grew 1.9 pct, matching the government's target, but slower than the 2.4 pct expansion in the previous fiscal year.

The slower growth came as domestic demand increased a marginal 0.2 pct in January-March from the previous quarter compared to the 1.1 pct jump in the December quarter, and non-residential investment marked its first sequential drop in five quarters.

Non-residential investment, virtually equivalent to corporate spending, fell 0.9 pct quarter-on-quarter

after a 2.3 pct jump in the previous quarter. Non-residential investment subtracted 0.1 percentage point from overall GDP, after having added 0.4 percentage point in the previous quarter.

'While spending by construction equipment makers was brisk, the capital outlays of electronics/telecom equipment makers declined while investment by general machinery makers, automakers and software developers slowed,' Gotoh said.

NLI Research Institute senior economist Taro Saito thinks the decline in capital spending was temporary, saying record profits at most Japanese companies, plus the yen's weakness, should boost capital outlays going forward.

The drop in capex was not surprising given the rapid increase during the December quarter, said Masamichi Adachi, senior economist at JP Morgan Securities.

'But given solid exports, a weak yen and continued profit growth, it would be difficult to think that the expansion in non-residential investment will fall part,' Adachi said.

While capital spending dropped, private consumption remained healthy, rising 0.9 pct sequentially in the March quarter, after growing 1.1 pct in the previous quarter.

Economists attributed the continued growth in consumption to the warm weather during the first three months of the year which spurred consumers to spend more on spring clothing and dine at restaurants.

But the slowdown in wage increases may affect growth in consumer spending in the next quarters, said Tokai Tokyo Securities chief economist Mitsuru Saito.

Nominal compensation of employees rose 0.2 pct year-on-year in the January-March quarter, the slowest pace since April-June 2005 when it rose 0.8 pct.

In terms of external demand, Japan's exports were brisk in the March quarter with net exports -- or the difference between exports and imports -- contributing 0.4 percentage point to GDP, up from 0.1 percentage point in the last quarter of 2006.

That trend could continue even if demand in the US -- still mostly Japan's biggest market -- slows down, said Informa Global Markets (Japan) economist Kenji Arata.

'Brisk exports to China and India whose economies are growing rapidly can compensate for the expected decline in exports to the US,' he said.

Overall, the latest GDP data suggest that the Japanese economy continues to recover at a modest pace and that may hold off any interest rate hike in the near term, economists said.

Still some economists think the next rate hike may take place before the end of this year, citing further progress in Japan's battle against deflation.

The GDP deflator, which measures the degree of deflation, was down 0.2 pct year-on-year in January-March, the smallest fall since April-June 1998 when the deflator dropped 0.1 pct. In the three months to December, the GDP deflator declined 0.5 pct from the previous year.

'While my main scenario is that the BoJ will hike interest rates in the October-December quarter, depending on what happens to crude oil prices, we cannot rule out the possibility of an earlier rate increase,' Informa's Arata said.

The central bank has kept its overnight call rate target, or the interest rate commercial banks charge each other for short-term funds, at 0.5 pct since it raised it from 0.25 pct in February.

(1 usd = 120.79 yen)