Japan's Economy Contracts a More-Than-Expected 1.2%

Sep 10, 2007 - Japan's economy contracted at almost twice the pace forecast by analysts in the second quarter, reinforcing speculation the central bank will leave interest rates unchanged this year.

The economy shrank at a 1.2 percent annual rate in the three months ended June 30 as business spending slumped, the Cabinet Office said in Tokyo today. The government initially forecast a 0.5 percent expansion.

Bond yields fell to the lowest level since February last year on expectations the central bank will keep its overnight lending rate at 0.5 percent to prevent the economy from falling into recession. Any rebound in growth depends on the severity of the housing slowdown in the U.S., the biggest export market for Japanese companies including Toyota Motor Corp. and Sony Corp.

"A move by the Bank of Japan is out of the question," said Takehiro Sato, chief economist at Morgan Stanley Securities Japan Ltd. in Tokyo. "A cloud is hanging over the domestic and global economy."

The median forecast of 31 economists surveyed by Bloomberg News was for the economy to recede at a 0.7 percent annual pace.

The yield on the benchmark 10-year bond slid 8 basis points to 1.51 percent at 3:55 p.m. in Tokyo. The Nikkei 225 stock average tumbled 2.2 percent. The yen traded at 113.26 per dollar from 113 before the report was published.

Quarterly Drop

Japan's economy contracted 0.3 percent from the previous quarter. The Cabinet Office revised the data to show that the last time the economy shrank was in the third quarter of 2006, when it fell 0.1 percent from the previous three months.

Toyota, Japan's largest automaker, saw its U.S. sales drop for the second straight month in August, the first back-to-back decline in 4 1/2 years. Weaker demand in California, Toyota's biggest U.S. market and one of the states where housing is slumping, was partially to blame. The company's shares fell 2.4 percent today.

Sony Corp. shares dropped 6 percent today, taking their decline the past two months to 18 percent. The world's biggest producer of game consoles makes about 70 percent of its sales outside Japan.

The nation's business investment fell 1.2 percent in the second quarter, reflecting a report last week that showed spending by Japanese companies unexpectedly slid in the period. Public investment was revised to a 2.6 percent drop from the previous estimate of a 2.1 percent decline.

Consumer Spending

Gains in household spending in the quarter helped counter the slump in corporate outlays. Spending by consumers, which makes up half the economy, was revised to show a 0.3 percent increase, from an initial estimate of a 0.4 percent gain.

Business and consumer spending were the main drivers of growth last year, reducing the economy's reliance on exports.

Investors now see a zero percent chance that the bank will raise the benchmark rate from 0.5 percent when policy makers conclude their next meeting on Sept. 19, according to Credit Suisse Group calculations based on interest-rate swaps.

Expectations of a rate increase have fallen since losses on U.S. subprime mortgages caused corporate credit costs to jump, global stocks to plummet and the yen to surge.

The Federal Reserve will probably cut its key rate to 5 percent from 5.25 percent when it meets Sept. 18, according to the median forecast of 111 economists surveyed by Bloomberg News. Those expectations rose last week after a report showed the U.S. economy lost jobs in August for the first time in four years.

'The Bottom Line'

"The bottom line is that there won't be any rate hikes in Japan as long as the U.S. economy keeps decelerating," said Yoshimasa Maruyama, a senior economist at BNP Paribas Securities Japan Ltd. in Tokyo.

Since July, Japan's economic growth has shown signs of losing momentum. The trade surplus shrank for the first time this year on weak export growth and industrial production fell. Household spending, a measure of consumer activity, had the biggest drop since December.

There are some indications the economy will accelerate again, albeit at a slower pace than some economists had been forecasting.

"There are enough warning signs in the latest business and consumer surveys to suggest that the subsequent rebound may be rather weaker than usual," Julian Jessop, an economist at Capital Economics in London, said in a note.

Manufacturing Production

Manufacturers expect industrial production to improve after July's drop. They forecast then that output would rise 6.8 percent in August and 2.5 percent in September.

Japan's broadest indicator of the outlook for growth was 70 percent in July. A reading of 50 or more indicates the economy may expand in three to six months.

"The recent rebound in the index is reassuring," said Jessop.

A report tomorrow is expected to show that machinery orders, which point to capital spending in three to six months, rose 5.3 percent in July, according to the median forecast of 21 economists surveyed by Bloomberg News.

"There is no change in Japan's economic trend overall," said Finance Minister Fukushiro Nukaga in Tokyo today. "We expect that the economy will continue its long-lasting growth."

Even after the contraction, Japan's economy expanded at a 2.5 percent annual pace in the first two quarters, the government said, higher than the economy's potential growth rate of 2 percent.