Japan's Consumer Prices Fall 0.1%; Production Drops After Quake

By Mayumi Otsuma

Aug. 31 (Bloomberg) -- Japan's consumer prices declined for a sixth straight month in July, signaling the world's second- largest economy has yet to overcome a decade of deflation. Industrial production and household spending dropped.

Core consumer prices, which exclude fresh food, fell 0.1 percent from a year earlier, the government said in Tokyo today, matching the median estimate of economists. Factory output dropped 0.4 percent and household spending slipped 0.1 percent.

Bonds rose as investors speculated the Bank of Japan would delay raising interest rates until it can gauge the effects of the U.S. mortgage recession on growth in the nation's biggest export market. Central bank Governor Toshihiko Fukui said last week the bank will decide policy by examining economic data and financial-market moves.

``Given the market turmoil and its negative implications for Japan's production and exports'' the Bank of Japan will find it hard to ignore negative data on consumer spending, said Kiichi Murashima, an economist at Nikko Citigroup Ltd. in Tokyo.

The yield on Japan's 10-year bond fell 2 basis points to 1.545 percent at 10:53 a.m. in Tokyo. The yen traded at 116.06 per dollar from 116.02 before the reports were published.

Mortgage Losses

Rate-increase expectations have fallen since losses on U.S. subprime mortgages this month caused corporate credit costs to jump, global stocks to plummet and the yen to surge.

Investors see a 14 percent chance policy makers will raise the key rate at the Sept. 18-19 meeting, according to Credit Suisse Group calculations based on interest payments.

Japan has struggled to shake off deflation that emerged after a stock and property-price bubble burst in the early 1990s and compelled the central bank to keep interest rates near zero percent. The Bank of Japan raised the benchmark overnight lending rate for the first time in almost six years in July 2006 and doubled it to 0.5 percent in February.

Factory production slid in July after an earthquake disrupted output at automakers Toyota Motor Corp. and Honda Motor Co.

Output would have risen had automakers not dragged the number down 1.2 percentage points, the Trade Ministry said. Companies surveyed forecast manufacturing to increase 6.8 percent in August.

Industrial Production

``Industrial production was affected by the earthquake, but if you look at the outlook, we needn't be too concerned,'' Economic and Fiscal Policy Minister Hiroko Ota said at a regular press conference in Tokyo.

Spending by households unexpectedly dropped for the first time in seven months, as a typhoon kept shoppers at home and a tax increase weighed on sentiment.

Employment prospects improved. The jobless rate fell to 3.6 percent in July, the lowest since February 1998, from 3.7 percent. A ratio that shows how many positions are on offer for each job seeker held at 1.07, near a 14-year low of 1.09.

``Steady improvement in the job market is a positive thing, but the question is when that's going to feed through to wages,'' said Hiroshi Shiraishi, an economist at Lehman Brothers Japan Inc. in Tokyo. ``The consumption data in July was affected by one-time factors, but the spending is decelerating.''

Tokyo Prices

Tokyo's core prices, seen as an indicator of the nationwide index, were unchanged in August from a year earlier, reversing two months of declines. Economists expected a 0.1 percent drop.

Atsushi Mizuno, a central bank board member, yesterday said prices probably hit bottom in March, when they fell 0.3 percent. The lone advocate for a rate increase since July said Japan's low borrowing costs contributed to the kind of excess lending that helped trigger the market turmoil.

``Mr. Mizuno has been set on raising rates for a long time,'' said Seiji Adachi, a senior economist at Deutsche Securities Inc. in Tokyo. ``Our focus is on whether other board members get closer to his view.''

The government doesn't share the central bank's inflation outlook. Fukushiro Nukaga, who became Finance Minister in a Cabinet reshuffle this week, said the economy has yet to overcome deflation and the central bank should coordinate policy with the government to stop prices from falling and spur growth.

Rising crude oil prices are helping to slow consumer-price declines. The effect from a tobacco-tax increase in July 2006 was offset by recent gasoline price gains, said Takuji Aida, chief market economist at Barclays Capital in Tokyo.

``Inflationary pressure in Japan is steadily bubbling under,'' Aida said. ``The lava will surface suddenly, not gradually, and that's why interest rates need to be normalized'' soon. He said prices will resume rising in the fourth quarter.

U.S. Economy: Expansion Was Faster Than Estimated (Update3)

By Courtney Schlisserman

Aug. 30 (Bloomberg) -- Surging exports and business spending propelled U.S. growth to the fastest pace in more than a year before turmoil in the credit markets forced the Federal Reserve to warn of a bleaker outlook.

Gross domestic product rose at a 4 percent annual rate in the second quarter, the Commerce Department said in Washington, up from an initial estimate of 3.4 percent. The median forecast of economists polled by Bloomberg News was 4.1 percent.

The figures may be the peak of the expansion for this year as the cost of borrowing increased in August and the Fed said that risks to growth ``increased appreciably.'' In a sign the job market is weakening, the Labor Department said today claims for unemployment benefits climbed to the highest level since April. A further report showed house prices in the second quarter rose at the slowest pace in a decade.

``The underlying economy was growing in the first half,'' said Peter Kretzmer, a senior economist at Banc of America Securities LLC in New York. ``We expect it to slow modestly, but not in such a pronounced way. It will slow enough, though, that the Fed will find an excuse'' to reduce interest rates, he said.

Kretzmer accurately predicted the pace of expansion.

The Fed's preferred inflation measure, which is tied to consumer spending and strips out food and energy costs, rose at a 1.3 percent annual rate. The pace of increase was the slowest in four years.

Treasury notes remained higher after the reports. The yield on the benchmark 10-year note declined 5 basis points to 4.51 percent at 5:07 p.m. in New York. A basis point is 0.01 percentage point. The Dow Jones Industrial Average fell.

Trade Deficit

A bigger jump in exports and smaller gain in imports contributed to a reduction in the trade deficit, the report on gross domestic product showed. Trade contributed 1.4 percentage points to growth, the most since 1996.

Spending on corporate construction projects and new equipment also boosted growth. Commercial construction jumped 28 percent, the most since 1981. Investment in equipment increased at a 4.3 percent pace, almost double the previous estimate.

Inventories, which were forecast to play a role in the projected increase in growth, were little changed from the initial GDP estimate published in July.

Jobless Claims

Initial unemployment claims climbed by 9,000 to 334,000 in the week that ended Aug. 25, the Labor Department said today in Washington. The four-week moving average, a less volatile measure, increased to 324,500 from 318,250.

Help-wanted advertising in American newspapers fell in July to the lowest level since 1958, and online job postings also declined. The Conference Board's index dropped to 25 last month, matching analysts' forecasts, from 26 in June. The trend in the help-wanted measure has fallen since 2000 as print media have been losing advertising to the Internet.

The deepest housing slump in 16 years is prompting builders and mortgage-lending companies such as American Home Mortgage Investment Corp. to fire workers. That may weigh on consumer spending, which accounts for more than two-thirds of the economy.

``Business psyche is being more and more affected by what's been going on in the credit markets,'' said Zoltan Pozsar, a senior economist at Moody's Economy.com in West Chester, Pennsylvania. ``If this continues for the next few weeks, it'll definitely be a sign that hiring is being affected by the credit- market problems.''

Home Prices

Prices for previously owned single-family homes rose an average of 3.2 percent from a year earlier, the smallest gain since 1997, the Office of Federal Housing Enterprise, said today in Washington. Prices gained 0.08 percent from the first quarter, the slowest since a decline in the final three months of 1994.

About 14 percent of banks raised standards for mortgages to their most creditworthy borrowers and 56 percent made it more difficult for people with limited or tainted records to get loans, according to a Fed survey of senior loan officers in mid- July.

In highlighting risks to growth, policy makers reversed their stance from their last meeting on Aug. 7 that inflation was the biggest risk to the economic expansion.

Traders and economists expect the Fed to lower its benchmark overnight lending rate between banks at or before policy makers next meet on Sept. 18. Chairman Ben S. Bernanke will discuss housing and monetary policy tomorrow, when he addresses the Kansas City Fed's annual symposium in Jackson Hole, Wyoming.

Residential Construction

Declines in residential construction subtracted 0.6 percentage point from growth in the second quarter, more than previously estimated.

Housing will probably deduct about a percentage point from GDP at least through early 2008, according to economists at JPMorgan Chase & Co.

As a result, growth will average 2.25 percent in the six months starting in October, a percentage point less than previously projected, Bruce Kasman, JPMorgan's chief economist, said in a note to clients last week.

Lehman Lowers Forecast

Lehman Brothers Holdings Inc. lowered its forecast last week for the period covering October through June 2008 to 1.8 percent, almost a half percentage point less than previously thought.

In one of the earliest economic readings to cover August, consumer confidence dropped by the most in two years, the Conference Board said this week. The measure retreated to 105 this month and the share of people who said jobs are plentiful declined.

In today's report, consumer spending was revised up to an annual rate of 1.4 percent from an initial estimate of 1.3 percent. The gain was still the smallest in a year.

``Our consumer is impacted obviously because they see the value of their homes go down, there's a sort of wealth effect,'' Farooq Kathwari, chief executive officer of Ethan Allen Interiors Inc., said in an interview on Aug. 28. ``Yet they're still interested in furnishing their homes, they're still buying.''

Today's GDP report included a first look at corporate profits for the quarter. Earnings adjusted for the value of inventories and depreciation of capital expenditures, known as profits from current production, rose 6.4 percent, the most in more than a year, to an annual rate of $1.65 trillion. Compared with a year earlier, profits were up 4.5 percent.

Japan's Retail Sales Drop on Storm, Sliding Sentiment (Update2)

By Jason Clenfield

Aug. 30 (Bloomberg) -- Japan's retail sales fell more than twice as much as economists expected, as a tax increase and a weekend typhoon kept shoppers away from the nation's department stores and car dealerships.

Sales declined 2.2 percent in July from a year earlier, the Trade Ministry said today in Tokyo, the biggest decline since June 2005. The median estimate of 25 economists surveyed by Bloomberg News was for a 0.8 percent decrease.

Stagnant wages and higher taxes may delay a recovery in spending and leave the economy dependent on sustained overseas demand. Though consumer spending is lackluster, economists attribute much of July's drop to a series of one-time events.

``All the bad factors seem to have fallen in July,'' said Azusa Kato, an economist at BNP Paribas in Tokyo. ``We don't expect consumption to keep deteriorating at this pace.''

The yen traded at 115.61 per dollar at 10:02 a.m. in Tokyo, from 115.72 before the report was published. The yield on Japan's 10-year bond rose 1.5 basis points to 1.595 percent.

Consumer sentiment sank to the lowest level since 2004 in July as gas prices rose to a 20-year high and the rollback of tax rebates a month earlier added to living costs. The government's loss of pension records may result in billions of yen in unpaid benefits, the Social Security Agency said in May.

There was one fewer Saturday in July compared with a year earlier and a typhoon washed out a three-day weekend.

Falling Shares

A 3.9 percent drop in the Topix stock index in July also damped consumer sentiment. Since then the index has declined a further 7.7 percent on concern subprime mortgage defaults will slow growth in the U.S., Japan's biggest export market. The market turmoil prompted the Bank of Japan to keep its overnight- lending rate at 0.5 percent last week.

Sales of clothing fell 9.7 percent in July from a year earlier, today's report showed. Automobile sales slumped 4.8 percent. Sales of fuel, meanwhile, increased 0.3 percent as gasoline prices surged.

Sales at large shops open for at least a year sank 3.8 percent, a backlash after rising at the fastest pace since 1998 in June, when department stores pushed forward the start of summer discounts.

Wholesale revenue rose 6 percent, the 24th consecutive monthly gain, led by cars and construction equipment for export. The divergence between wholesale and retail figures underscores the economy's reliance on demand from abroad.

Wages Slump

Wages have fallen for seven months running as younger workers replace retiring baby boomers, whose paychecks tend to be higher because of Japan's seniority-based compensation.

Those younger workers are showing a feeble appetite for spending. A survey last week of Japanese in their 20s by the Nikkei newspaper showed that more than a third of the country's young people dedicate their disposable income to savings. Only one in four young Tokyoites wants to buy a car, down from one in two in 2000, the survey showed.

The unemployment rate held at a nine-year low of 3.7 percent for a second month in July, a report due tomorrow at 8:30 a.m. will probably show, according to economists surveyed by Bloomberg News. The number of jobs has increased by 1.5 percent in the past 12 months, according to the central bank.

Today's retail report only accounts for spending in shops. It excludes Internet retailing and outlays on services provided by gyms, restaurants and movie theaters. Spending on travel, for example, rose at 10 times the pace of retail sales last year, according to the Japan Association of Travel Agents.

Mizuno Says Loan Crisis Shows Why Rates Need to Rise (Update1)

By Lily Nonomiya

Aug. 30 (Bloomberg) -- Overinvestment was a major cause of the U.S. subprime mortgage crisis and illustrates why the Bank of Japan needs to raise interest rates, central bank policy maker Atsushi Mizuno said.

``Overinvestment amid conditions of ample global liquidity was a major factor in causing the subprime issue,'' Mizuno said today in a speech in Kofu, Japan. The market turmoil ``is proof that keeping rates at levels that stray from fundamentals could actually cause instability.''

Since July, Mizuno, 48, has been the lone advocate of raising rates, arguing that keeping borrowing costs too low could fuel risky investment and hurt economic growth in the long term. The bank's 0.5 percent short-term rate, the lowest among major economies, has encouraged investors to borrow in Japan to buy higher-yielding assets abroad in so-called carry trades.

Mizuno's calls for rate increases have been rejected by his fellow board members, who voted to keep them on hold last week after the market turmoil. Losses on U.S. subprime mortgages drained liquidity from markets, causing global stocks to plummet and the yen to surge as investors sold riskier assets funded by loans in Japan.

Reserve Bank of Australia Governor Glenn Stevens said this month that ``the sooner the Japanese interest rates are able to be normal again, the better from the point of view of the global financial system.''

Central banks in the U.S., Europe and Japan pumped more than $350 billion in the banking system and the Federal Reserve cut the rate at which it lends to banks to ease access to credit.

Small Effect

``We can expect the repricing process in financial markets to move forward once the current liquidity issues subside,'' Mizuno said. ``The chances of this having a serious impact on the real economy are small.''

Mizuno said there's no reason for the bank to lower its forecasts for economic growth and inflation following the subprime collapse and resulting financial-market instability.

``While it's possible that the U.S. economy could slow a bit more than expected, this may be absorbed by solid global growth,'' he said, while adding that the subprime issue remains ``a risk.''

Investors are scaling back expectations for a September rate increase. They now see a 22 percent chance of a move at the Sept. 18-19 meeting, down from 36 percent at the end of last week, according to Credit Suisse Group calculations based on interest payments.

Prices have failed to pick up even as the economy grows. A report tomorrow is expected to show consumer prices excluding fresh food fell 0.1 percent in July from a year earlier, a sixth monthly drop, according to the median estimate of 40 economists.

Bernanke Says Fannie, Freddie Asset Caps Should Stand (Update3)

By James Tyson

Aug. 29 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said relaxing portfolio limits on Fannie Mae and Freddie Mac isn't necessary for the two largest U.S. mortgage finance companies to help stem a surge in foreclosures.

Federal caps on the companies' combined $1.4 trillion in mortgages and mortgage bonds ``need not be lifted to allow them to accommodate new borrowers,'' Bernanke said in an Aug. 27 letter to Senator Charles Schumer, a New York Democrat.

Bernanke's view is in line with the companies' regulator and with President George W. Bush. The Office of Federal Housing Enterprise Oversight on Aug. 10 rejected requests to allow the government-chartered firms to buy more home loans to ease a credit crunch in the mortgage market. Schumer and other Democrats have called for relaxing the restrictions, saying the companies could fill a gap left by investors who fled the market.

Ofheo, as the regulator is known, imposed the limits last year after Fannie Mae and Freddie Mac disclosed accounting misstatements of $11.3 billion. To lift the ceilings, the companies must complete an overhaul of accounting and governance and restore timely financial reporting, the agency said.

The constraints ``were imposed for safety and soundness reasons,'' Bernanke said. ``Policy makers may also want to encourage'' Fannie Mae and Freddie Mac to package and guarantee more home loans as securities for sale to investors, a business line that is ``not constrained by their portfolio caps.''

`Closely Monitoring'

The Fed chief also said that the central bank ``is closely monitoring developments in financial markets.'' He noted that the interest-rate setting Federal Open Market Committee said in a statement it ``is prepared to act as needed to mitigate the adverse effects on the economy'' from the turmoil in markets.

Created by Congress to increase financing for home loans, Fannie Mae and Freddie Mac own or guarantee 40 percent of the $10.9 trillion U.S. residential mortgage market. They profit by holding mortgages and mortgage-backed securities as investments and by charging a fee to guarantee and pool together home loans as bonds.

The companies ``should be encouraged to provide products for subprime borrowers to the extent permitted by their'' federal charters, Bernanke said without elaboration.

The Fed and U.S. Treasury since 2005 have portrayed the assets of Fannie Mae and Freddie Mac more as a threat to market stability than as a lifeline in times of declining mortgage credit.

The two companies could trigger financial market turmoil should they fail to hedge their holdings against interest rate changes and other risks, the Fed and Treasury have said. They have called on Congress to mitigate the ``systemic risk'' by creating a supervisor with power to pare the companies' assets.

Strengthened Oversight

Bush said Aug. 9 that Congress must pass legislation strengthening oversight of the companies before the administration lifts the restrictions on the portfolios.

Fannie Mae rose $2.19 to $65.76 at 4:20 p.m. in New York Stock Exchange composite trading, while Freddie Mac gained $2.05 to $63.25. Shares of both companies pared gains after Schumer released the letter, before resuming their advance.

Fannie Mae must restrict its portfolio to $727.2 billion, the level on Dec. 31, 2005, while Freddie Mac must constrain annual growth of its $720.6 billion portfolio to 2 percent. The two also can't buy mortgages of more than $417,000 for a single- family home in most states.

Fed Put Inflation Skepticism Above Credit Concern (Update5)

By Scott Lanman

Aug. 28 (Bloomberg) -- Federal Reserve officials put aside concerns about the rising cost of credit at their Aug. 7 meeting because they weren't convinced a slowdown in inflation would last, minutes of the gathering said.

Ten days before the Fed was forced to cut a key interest rate, the Federal Open Market Committee was given lower growth forecasts by staff economists, and noted that ``strains in financial markets'' jeopardized the expansion. Further turmoil might require a response, the panel acknowledged, though that sentiment didn't appear in the statement after the meeting.

``Policy makers would need to watch the situation carefully,'' the central bank said. ``For the present, however, given expectations that the most likely outcome for the economy was continued moderate growth, the upside risks to inflation remained the most significant policy concern.''

The records don't include the Aug. 16 emergency video conference when the FOMC reversed course and lowered the discount rate, saying that risks to economic growth had ``increased appreciably.'' The benchmark lending rate was kept unchanged at 5.25 percent.

Policy makers underestimated the contagion from subprime credit markets to less risky borrowers, the minutes showed.

``Funding had become more costly and difficult to obtain for riskier corporate borrowers, but there had been little net change in the cost of credit for investment-grade businesses,'' the Fed said.

Borrowing Costs

The yield premium investors demand to buy investment-grade corporate bonds compared with benchmark Treasury securities had jumped almost a quarter of a percentage point in the two weeks before the Aug. 7 meeting. The gap widened to 1.47 percentage points on Aug. 21, the highest in four years, Merrill Lynch & Co. data show.

``The mistake the Fed made is that the market was clearly coming unglued prior to the meeting,'' said Scott Minerd, who helps oversees $24 billion of stocks and bonds at Guggenheim Partners LLC in Santa Monica, California. By maintaining the inflation bias, ``it telegraphed to the market that this Fed was really out of touch with how severe the credit dislocation was.''

At the same time, the minutes showed officials may have given more weight to economic-growth risks than their statement suggested.

JPMorgan View

While the Aug. 17 statement acknowledged such dangers ``increased somewhat,'' the minutes go a step further by alluding to the possibility of an interest-rate cut and noting that policy makers would monitor the situation, Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, said in a research note.

Stocks extended declines after the report. The Standard & Poor's 500 index closed down 2.4 percent at 1,432.36 in New York.

Chairman Ben S. Bernanke may offer insight on the Fed's current assessment of the economic outlook when he speaks on Aug. 31. Bernanke will address the Kansas City Fed's annual symposium in Jackson Hole, Wyoming, traditionally attended by most Fed governors and district-bank presidents.

As of three weeks ago, policy makers ``expected a return to more normal market conditions, but recognized that the process likely would take some time,'' the minutes showed. They noted that ``mortgage loans remained readily available to most potential borrowers,'' and the ``supply of credit to finance real investment did not appear significantly diminished.''

Traders and economists expect the Fed to lower its benchmark rate at or before the next meeting, on Sept. 18, according to futures traded on the Chicago Board of Trade.

Inflation, Growth

As policy makers gathered three weeks ago, reports showed inflation had slowed while economic growth had accelerated in the second quarter. Gross domestic product rose at a 3.4 percent annual pace in April to June, the fastest in more than a year.

On inflation, ``meeting participants believed that the readings for the past few months likely had been damped by transitory factors and did not provide reliable evidence that the recent level would be sustained,'' the minutes said.

Officials kept the target rate for overnight loans between banks, the main policy tool, at 5.25 percent for a ninth straight meeting. While the Fed conceded that ``downside risks to growth have increased somewhat,'' citing tumult in financial markets, officials reiterated in the Aug. 7 statement that inflation was the ``predominant'' policy concern.

Assessment Faulted

That disappointed some investors and observers, who argued a balanced assessment was warranted by increasing signs of stress in financial markets, sparked by an exodus from securities backed by subprime mortgages.

The S&P 500 Index fell 5.7 percent from its record high on July 16 through Aug. 6. The premium on investment-grade corporate bond yields compared with benchmark Treasuries on July 25 jumped the most in five years, data from Merrill Lynch & Co. showed. Sam Molinaro, the chief financial officer of Bear Stearns Cos., where two hedge funds failed in June, said Aug. 3 that the fixed-income market was in the worst shape in 22 years.

Fed officials ``still saw moderate economic expansion in coming quarters as the most likely outcome but that the downside risks to growth had increased,'' according to the Aug. 7 minutes.

Fed staff economists said the U.S. economy would grow at a ``somewhat'' slower pace in the second half of 2007 and in 2008 than previously anticipated. They cited figures released July 27 showing the economy expanded an average 3.2 percent from 2004 through 2006, revised down from 3.5 percent. That prompted the staff to judge the economy's speed limit had fallen.

Cash Injection

Three days after officials met, the Fed pumped $38 billion into the banking system -- the most since the 2001 terrorist attacks -- in its first effort to contain the credit crunch. The effort failed to quell the upheaval, as the amount outstanding of commercial paper, a key short-term financing tool for some finance companies, slid the most in six years.

The following week, with borrowing continuing to dry up, the Fed took steps unprecedented in recent years: it cut the rate on direct loans to banks and issued a new outlook that recognized economic risks had risen ``appreciably'' and omitted any mention of inflation.

Minutes of the FOMC's Aug. 16 videoconference will be included in records of the Sept. 18 meeting, to be released Oct. 9. The Board of Governors' separate decision to cut the discount- lending rate to 5.75 percent from 6.25 percent will be detailed in another report, around Oct. 16.

Japan's Industrial Production Probably Slipped After Earthquake

By Lily Nonomiya

Aug. 29 (Bloomberg) -- Japan's industrial production probably slipped in July after an earthquake disrupted output at Toyota Motor Corp. and Honda Motor Co.

Production fell a seasonally adjusted 0.3 percent from June, according to the median estimate of 42 economists surveyed by Bloomberg News. The Ministry of Economy, Trade and Industry will release the report at 8:50 a.m. on Aug. 31.

Riken Corp., Japan's largest maker of piston rings, shut a factory for a week following the July 16 quake, cutting off supplies for automakers and forcing them to temporarily close plants. Rather that dwell on July's output decline, the Bank of Japan is expected to focus on whether the U.S. housing-market crisis will affect demand for Japanese goods in coming months before deciding to raise interest rates.

``The slip in production will be modest and won't be looked at that closely,'' said Naoki Iizuka, senior economist at Mizuho Securities Co. in Tokyo. ``The BOJ needs to confirm that the subprime issue isn't hurting demand before it can raise interest rates.''

Separate reports on the same day may show consumer prices fell for a sixth month in July, unemployment stayed at a nine- year low and household spending gained for a seventh month.

Global stocks plummeted and the yen surged this month after losses on U.S. subprime mortgages drained liquidity from markets. Central banks in the U.S., Europe and Japan pumped more than $350 billion in the banking system and the Federal Reserve cut the rate at which it lends to banks to prevent further turmoil.

Subprime Effect

Bank of Japan Governor Toshihiko Fukui and his policy board voted 8-1 to keep the benchmark overnight lending rate unchanged at 0.5 percent last week. The bank needs to watch how the subprime collapse might affect the U.S. and global economies, Fukui told reporters after the decision.

Investors are scaling back expectations for a September rate increase. At 8:38 a.m. today they saw a 30 percent chance of a move at the Sept. 18-19 meeting, down from 36 percent at the end of last week, according to Credit Suisse Group calculations based on interest payments.

Riken had to halt production last month after the magnitude 6.8 quake in Niigata prefecture damaged its engine-parts plants. Honda, Japan's second-largest carmaker, cut output 11 percent, the biggest drop in two years. Bigger rival Toyota pared manufacturing 8.4 percent, also the largest decline since 2005, the companies said on Aug. 28.

Automakers pledged to increase production this month to make up for the cuts in July, though slower U.S. consumer spending may force them to scale back those plans.

U.S. Demand

``We're already seeing that U.S. demand is stalling,'' said Seiji Adachi, a senior economist at Deutsche Securities Inc. in Tokyo. ``Exports are going to take a hit if weaker consumer spending translates into poor auto sales and demand in Japan isn't going to be strong enough to offset that.''

Exports, which drove more than a third of Japan's growth last year, are already showing signs of cooling. The trade surplus narrowed for the first time in six months in July as overseas demand for automobiles slowed.

Shipments abroad were a drag on economic growth in the second quarter after leading the expansion in the first three months of 2007. The economy grew at an annual 0.5 percent in the April-June period, slowing from 3.2 percent in the first quarter.

Meanwhile, consumer prices excluding fresh food fell 0.1 percent in July from a year earlier, a sixth monthly drop, according to the median estimate of 40 economists.

An increase in the tobacco tax in July 2006 offset the thrust from recent gains in gasoline prices, said Takuji Aida, chief economist at Barclays Capital in Tokyo.

``If gasoline prices stay around current levels, core prices will probably turn positive in the fourth quarter,'' Aida said. ``We still see a chance the Bank of Japan will hike the key rate in September or October.''

Fukui repeated on Aug. 23 his argument that consumer prices will resume rising over the long term as the economy expands.

The following table shows forecasts for the percentage changes in July factory production from the previous month and a year earlier.

U.S. Economy: Confidence Weakens by Most in Two Years (Update4)

By Bob Willis

Aug. 28 (Bloomberg) -- Americans' confidence dropped by the most since Hurricane Katrina two years ago, in the first report to reflect the credit-market turmoil in August.

The survey underscores the Federal Reserve's concern that risks to the six-year economic expansion have ``increased appreciably.'' Separate figures showed home prices suffered the biggest decline since at least 2001.

The New York-based Conference Board's index retreated to 105 this month, from 111.9 in July. Economists had forecast a reading of 104, according to a Bloomberg survey. Property values in 20 metropolitan areas decreased 3.5 percent in June from a year earlier, according to a report today by S&P/Case-Shiller.

``Consumers are obviously paying attention to what's going on and are a little worried by it,'' said Adam York, an economist at Wachovia Corp. in Charlotte, North Carolina. ``We are not expecting them to spend the way we thought they would a few months ago.''

Wachovia economists accurately predicted the confidence figure for this month, which declined from a near six-year high in July.

The housing recession is making it harder for Americans to tap home equity to finance the spending that accounts for 70 percent of the economy. A slowdown in hiring and slimmer pay raises may further weaken consumer sentiment and buying power.

``The things that are weighing on the consumer are getting pretty imposing,'' said Gregory Miller, chief economist at SunTrust Banks Inc. in Atlanta, which last week announced job cuts. ``The equity that he's generated in his house over the years has been undercut'' by falling prices.

Stocks Weaken

Stocks declined for a second day after Merrill Lynch & Co. analysts said tighter credit markets will hurt bank earnings. The Dow Jones Industrial Average fell 280 points, or 2.1 percent, to 13,041.85. Treasury bills rose for the first time in six days.

Fed policy makers believed ``strains in financial markets'' jeopardized the expansion and further turmoil might require a response, according to the minutes of their Aug. 7 meeting issued today. Still, they put aside concerns about the rising cost of credit because they weren't convinced a slowdown in inflation would last.

The Case-Shiller report also showed that prices nationally dropped 3.2 percent in the second quarter from a year before. That compares with a 1.6 percent year-over-year drop the prior quarter.

Survey Details

The forecast drop in confidence reflected the median estimate in a Bloomberg survey of 73 economists from an originally reported July reading of 112.6. Estimates ranged from 99 to 108.

The Conference Board's measure of present conditions fell to 130.3 from 138.3 in July. The gauge of expectations for the next six months dropped to 88.2 from 94.4.

The share of consumers who said jobs are plentiful declined to 27.5 percent in August from 30 percent in July. The proportion of people who said jobs are hard to get increased.

The proportion of people who expect their incomes to rise over the next six months slipped to 19.1 percent from 19.2 percent. The share expecting more jobs fell to 13 percent from 13.8 percent.

The Conference Board's index tends to be more influenced than other sentiment gauges by consumer attitudes about the state of the labor market, economists said.

Other confidence measures have also showed declines.

Other Measures

The Reuters/University of Michigan preliminary index of consumer sentiment fell to its lowest in a year this month, it reported Aug. 17.

The ABC/Washington Post Consumer confidence index fell to minus 20 in the week ending Aug. 19, its lowest level since October 2005.

Plunging stock prices in the wake of a global credit crunch helped undermine consumer sentiment. The Standard & Poor's 500 index fell as much as 9.4 percent from its July 19 historic high to Aug. 15, when it started to recover.

The labor market, while resilient, is showing signs of weakening. Unemployment rose in July to 4.6 percent from 4.5 percent, still near the lowest in six years. Job growth slowed to 92,000 last month from 126,000 the prior month, down from last year's average of 189,000 a month. Growth in hourly earnings slowed to 3.9 percent in July from a year earlier, down from a nine-year high of 4.3 percent in December.

Stable Spending

Consumer spending growth will probably average a 2.5 percent pace in the second half of 2007, unchanged from the first six months, according to economists surveyed by Bloomberg News. That's down from a 3.4 percent pace in the last half of 2006.

The worst housing recession in 16 years is weakening consumer spending and costing jobs. Sales of previously owned homes fell in July to the lowest level in almost five years, while the glut of unsold homes rose to a 16-year high, the National Association of Realtors reported Aug. 27.

As global credit markets seized up on concerns over the pricing of funds backed by subprime mortgages, the Fed on Aug. 17 announced a surprise cut in the discount rate. The Fed said downside risks to growth had ``increased appreciably,'' in a statement interpreted by investors as signaling a move away from its tightening bias.

The credit crunch is costing jobs. San Diego-based Accredited Home Lenders Holding Co. on Aug. 22 said it would close more than half its operations and fire about 1,600 people.

Bank Firings

Two days before, Atlanta-based SunTrust Banks Inc. said it planned to cut about 2,400 employees this year as profit from retail and commercial banking declines.

Weaker home prices translate into slowing car sales, said Michael Jackson, chief executive officer of AutoNation Inc., the largest U.S. auto retailer, said in a July 26 interview from Fort Lauderdale, Florida.

``There is a direct link between housing and the distress it creates around consumers for big-ticket items,'' said Jackson.

Still, falling gasoline prices have provided consumers with some relief. Prices of regular unleaded gasoline fell from as high as $3.05 a gallon last month to $2.78 a gallon on Aug. 22. Prices are still up 30 percent from their lows for 2007 of $2.14 a gallon on Jan. 24.

China Inflation, Currency Pose Problems, Central Banker Says

By Zhang Dingmin

Aug. 28 (Bloomberg) -- A Chinese central bank official said a stronger currency, growing trade surplus and accelerating inflation are potentially ``destabilizing'' to the world's fastest-growing major economy.

Zhang Tao, deputy international department director of the People's Bank of China, said today in Beijing at the Third Beijing-Tokyo Forum that failure to deal with them may lead to an economic ``turning point.''

China's economy expanded 11.9 percent in the second quarter, the fastest in more than 12 years. Central Bank Governor Zhou Xiaochuan has raised interest rates four times this year, trying to curb price growth, ballooning asset values and overcapacity in manufacturing.

U.S. lawmakers have pushed China to allow faster gains in its currency, which they say is undervalued to give Chinese exporters an unfair advantage. The renminbi, as the currency is also known, has gained 9.5 percent since the end of the fixed exchange rate in July 2005.

``We want the renminbi's exchange-rate system to be more flexible and more responsive to market demand and supply,'' Zhang said today. ``But the exchange rate doesn't determine everything.''

China's trade surplus surged 67 percent in July from a year earlier to $24 billion, helping send the country's foreign- exchange reserves to $1.3 trillion. Consumer prices rose by 5.6 percent, the highest rate in more than 10 years as money supply climbed 18.5 percent, the most in more than a year.

The government is setting up a new investment company that will buy $200 billion of reserves from the central bank to seek higher returns. China wants to ``explore a road different from the traditional way'' in managing the reserves, Zhang said without elaborating.

Battellino Says Pressure in Australian Money Market (Update3)

 
By Gemma Daley and Laura Cochrane

Aug. 28 (Bloomberg) -- Australia's money market remains ``under pressure'' and the central bank will intervene if needed to stabilize the cost of credit, Reserve Bank Deputy Governor Ric Battellino said.

Australia's central bank added A$3.87 billion ($3.2 billion) to the financial system on Aug. 17. It has injected more than A$3 billion only three times this year, all since Aug. 10.

``These operations have held the cash rate at the target and helped stabilize conditions more normally. Nonetheless some pressures remain,'' Battellino told a retail financial services forum in Sydney today, according to speech notes. ``If market developments warrant, the bank has the scope to further expand the provision of liquidity.''

Central banks pumped billions of dollars of emergency cash into markets this month as commercial banks became hesitant to lend.

Sales of previously owned homes in the U.S. fell to a five- year low in July and the glut of unsold properties climbed to their highest since 1991, according to a report by the National Association of Realtors in Washington yesterday. The data sent investor optimism about the outlook for the U.S. financial markets to a one-year low amid concern the housing slump will deepen.

`Banks Sound'

Australian banks are in ``very sound'' condition and have experienced ``minimal credit losses,'' Battellino said.

``They were nonetheless affected by the spread of the global money-market turmoil,'' he said. ``Yields on asset-backed commercial paper as yet haven't fallen, indicating a continuing high degree of nervousness.

``A market adjustment had to take place in commercial-backed paper yields. The problem isn't over yet, it's a global situation that comes from the U.S. subprime market.''

Yields on short-term debt in Australia surged more than 30 basis points, or 0.30 percent, in the past two weeks to between 30- 40 basis points more than the benchmark swap rate, according to the Commonwealth Bank of Australia, the nation's second-largest lender.

Units of Australian banks such as Westpac Banking Corp. and Commonwealth use short-term loans to finance investment in longer- term securities such as asset-backed bonds. The profit usually delivered from this strategy is being cut by rising yields.

Bank Bills

``Activity in this market dried up sharply, the effect being that for a time funding wasn't available at any price,'' Battellino said. ``The volume of securities issued has fallen, and the maturities have shortened.''

About A$60 billion of commercial paper, with maturities from 30 to 90 days, is typically sold in Australia each month, according to figures from Standard & Poor's.

The Reserve Bank's operations undertaken in bank bills has risen to 80 percent, compared with the usual 30 percent, Battellino said.

The Reserve Bank on Aug. 8 raised its benchmark interest rate to 6.5 percent, the highest in 11 years, to curb inflation.

The Australian dollar snapped six days of gains, falling to 82.52 U.S. cents at 9.59 a.m. in Sydney from 83.18 cents late in Asia yesterday.

BOJ to Raise Interest Rates Gradually, Minutes Show (Update1)

 
By Jason Clenfield and Mayumi Otsuma


Aug. 28 (Bloomberg) -- The Bank of Japan will raise interest rates gradually based on developments in the economy and prices, minutes released today show.

``The bank would adjust the level of interest rates gradually in accordance with improvements in the economic and price situation,'' policy makers said at the July 11-12 meeting. Members agreed that their ``basic thinking remained unchanged.''

The bank kept the benchmark overnight lending rate at 0.5 percent at the meeting, which was held before the threat of a global credit crunch compelled central banks, including the Bank of Japan, to inject extra funds into their financial systems. The bank stood pat again on Aug. 23 after the market turmoil clouded the outlook for Japan's economic growth.

Governor Toshihiko Fukui told reporters after last week's decision that keeping borrowing costs too low may spur risky investments, suggesting the bank still plans to raise rates.

``The economy is developing much as the Bank of Japan had expected, and Japanese money markets have worked relatively well throughout the global crisis,'' said Julian Jessop, chief international economist at Capital Economics in London. ``The bank will therefore want to continue to return interest rates toward more normal and sustainable levels.''

The yen traded at 115.57 per dollar at 9:42 a.m. in Tokyo from 115.63 before the minutes were published.

Investors see a 34 percent chance policy makers will raise the key rate at the Sept. 18-19 board meeting, according to Credit Suisse Group calculations based on interest payments.

Subprime Slump

Some board members at the July meeting suggested the U.S. housing market slump might impede economic growth. Should losses on subprime mortgage investments ``seriously'' affect credit markets, damage to the Japanese and global economy ``could not be ruled out,'' they said, according to the minutes.

One member said the ``slowing of the increase in housing prices had reduced the availability of consumer credit, thus affecting consumption behavior'' in the U.S. Still, the nine members agreed that the world's largest economy would probably achieve a soft landing by the year's end.

Fukui will be watching the subprime issue ``very closely because the Japanese outlook is intrinsically linked to the global economic outlook,'' said Katie Dean, a senior economist at Australia & New Zealand Banking Group Ltd. in Melbourne. ``The likelihood of the Bank of Japan raising rates before the end of this year is now very slim.''

Mizuno's Dissent

One policy maker said raising interest rates last month was ``justified by economic conditions,'' the minutes show. Board member Atsushi Mizuno was the sole dissenter in July and August, proposing a rate increase at both meetings.

Mizuno is scheduled to give a speech to business executives on Aug. 30 at 10 a.m. in Kofu, near Tokyo. He will also hold a press conference later that day.

The members agreed that Japan's consumer-price inflation would probably hover around zero in the coming months but that prices are likely to rise in the long term.

Consumer prices excluding fresh food probably fell 0.l percent in July, a sixth monthly drop, according to the median estimate of 40 economists surveyed by Bloomberg News.

German August Business Confidence Probably Fell to 10-Month Low

 
By Simone Meier

Aug. 28 (Bloomberg) -- German business confidence probably fell to the lowest level in almost a year in August after the rising cost of credit clouded the outlook for economic growth, a survey of economists shows.

The Ifo research institute's sentiment index fell to 105.4, the lowest since October 2006, from July's 106.4, according to the median of 36 forecasts in a Bloomberg News survey. The institute will release the figures, based on responses from 7,000 executives, at 10 a.m. in Munich today.

Contagion from the U.S. subprime mortgage debacle raised concern that companies will find it harder to borrow just as the economy of the 13 nations sharing the euro starts to lose momentum. German investor confidence fell to an eight-month low and growth in the region's manufacturing and service industries slowed in August.

``The best in terms of growth is probably behind us,'' said Sandra Petcov, an economist at Lehman Brothers International in London. ``If financial market turbulence were to affect lending, it could certainly have more serious repercussions on the economy.''

Ifo conducted the survey from Aug. 3 to Aug. 27, according to spokesman Andre Kunkel. Responses of about two-thirds of participants reflected the market turmoil, Kunkel said. The U.S. Federal Reserve cut the discount rate, at which it makes direct loans to banks, on Aug. 17 and global stocks rebounded.

Slowing Growth

Growth in the euro region slowed to 0.3 percent in the second quarter, the least since the end of 2004, from a 2006 peak of 0.9 percent. The slowdown was caused in part by the biggest drop in construction in a decade in Germany, Europe's largest economy.

For Europe, credit-market concern deepened Aug. 9 after several banks in the region acknowledged their vulnerability to increasing defaults on U.S. subprime mortgages, those to borrowers with a poor credit history. Landesbank Baden- Wuerttemberg, Germany's largest state-owned bank, on Aug. 27 agreed to buy Landesbank Sachsen Girozentrale after the public lender was bailed out.

European companies were already dealing with a stronger euro, making their goods less competitive abroad, a 17 percent increase in oil prices this year and higher interest rates.

The euro's 17 percent gain against the dollar in less than two years reduced the competitiveness of European exports at the same time as the housing slump curbed growth in the U.S. economy, the world's largest. The euro touched a record $1.3852 July 24.

BMW, Audi

Bayerische Motoren Werke AG, the world's largest luxury carmaker, on Aug. 1 reported a bigger decline in second-quarter profit than analysts had estimated because of the euro's strength. Audi AG, Volkswagen AG's luxury unit, said last month it expects lower earnings, partly because of currency swings.

Still, in its monthly report published Aug. 20, the Bundesbank said financial-market turbulence is ``no reason'' to change its view that the economic outlook is ``still favorable.''

European Central Bank President Jean-Claude Trichet yesterday refused to be drawn on the course of interest rates, saying the bank's council will decide at its Sept. 6 meeting. He didn't repeat his August call for ``strong vigilance'' on inflation, words he used to signal all eight of the bank's increases in the benchmark rate since late 2005. The rate now stands at 4 percent.

M3 money supply, which the ECB uses as a gauge of future inflation, probably accelerated in July, a Bloomberg survey shows. The ECB will release that figure at 10 a.m. today.

``If risk aversion continues to trend lower over the next week or so, then we'll definitely see a 25-basis-point rate increase by the ECB'' next month, said Michael Rottmann, an economist at Unicredit MIB in Munich.

Investors expect the ECB to raise borrowing costs once more this year, futures trading shows. The implied rate on the three- month Euribor contract for December settlement was at 4.42 percent yesterday.

The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 16 basis points more than the ECB's benchmark rate since the currency's start in 1999.

Home Resales in U.S. Probably Dropped in July for Fifth Month

 
By Shobhana Chandra


Aug. 27 (Bloomberg) -- U.S. sales of previously owned homes probably fell in July for a fifth consecutive month, showing the housing slump that triggered a collapse in credit markets will drag on, economists said before a report today.

The National Association of Realtors may report home resales declined 0.9 percent to an annual rate of 5.7 million, the slowest pace since October 2002, according to the median forecast of 70 economists in a Bloomberg News survey.

With no recovery in sight for residential real estate, lower property values and harder-to-get mortgages threaten to weaken consumer spending, economists said. The Federal Reserve this month acknowledged a growing risk to economic growth in the wake of subprime defaults and a plunge in stock prices.

``The long unwind in the housing sector will continue well into next year,'' said Joseph Brusuelas, chief U.S. economist at IDEAglobal in New York. ``The inventory of new and existing housing is far too large. The subprime crisis has eliminated the marginal buyers from the market.''

The Realtors group will release existing home sales figures at 10 a.m. in Washington. Estimates of the annual sales rate ranged from 5.5 million to 6 million in the Bloomberg survey.

New Home Sales

New home sales unexpectedly rose in July for the second time this year, to an annual pace of 870,000, the Commerce Department reported Aug. 24. Purchases may show renewed weakness as turmoil in credit markets pushes some mortgage lenders out of business and prompts others to restrict lending, economists said.

Monthly figures on home resales are compiled from contract closings and may reflect sales agreed upon weeks or months earlier, while new home purchases are recorded when a contract is signed, making them a more timely barometer. Resales account for about 85 percent of the U.S. housing market.

The Fed cut the rate charged on direct loans to banks Aug. 17 to try to increase the availability of capital after global stock markets plunged on concern that the subprime default crisis will spread and destabilize the financial system.

``The downside risks to growth have increased appreciably,'' policy makers said in a statement that day, reversing their stance Aug. 7 that inflation was the greatest risk.

Delinquencies on loans to subprime borrowers -- or people with poor-credit histories -- hit a five-year high in the first quarter, and builders started work on the fewest homes in a decade in July, recent reports show.

Lending Standards

Tighter rules for loans ``could further dampen residential investment,'' Fed Bank of Richmond President Jeffrey Lacker said Aug. 21 in a speech in Charlotte. ``Recent data on actual housing market activity have dampened my optimism'' about a bottoming-out in the industry, he said.

Lacker also predicted ``the drag from housing will continue for some time.''

Economists agree the glut of unsold properties is unlikely to ease anytime soon, and will put pressure on prices to fall further. Prospective homebuyers are waiting for better bargains, while subprime defaults and rising foreclosures raise the risk that more houses will get thrown back on the market.

Toll Brothers Inc., the largest U.S. luxury homebuilder, said third-quarter profit fell 85 percent as the deepening housing slump cut sales, increased cancellations and forced the company to write down property.

``We continue to wrestle with the interrelated challenges of softer demand and excess housing supply in most markets,'' Chief Executive Officer Robert Toll said on a conference call Aug. 22. ``Traffic is pretty stinky out there.''

In wider repercussions, some companies are facing limited access to credit. Countrywide Financial Corp., the largest U.S. mortgage lender, had to tap a credit line from its banks after being shut out of the commercial-paper market. Bank of America Corp. last week agreed to invest $2 billion in the company.

As Bernanke Retreats to Wyoming, Critics Ask Is He Prime Time

 
By Scott Lanman


Aug. 27 (Bloomberg) -- Ben S. Bernanke's critics from Washington to Wall Street are starting to ask whether the Federal Reserve chairman is ready for a prime-time crisis.

The global credit crunch is proving the severest test of Bernanke's 18-month tenure atop the U.S. central bank as he tries to avoid a recession while steering clear of bailing out those who made risky investments.

Some seasoned Fed watchers say he should have avoided the optimistic assertion that the damage caused by subprime mortgages was ``contained'' before the collapse of credit in the world's money markets prompted extraordinary central bank intervention earlier this month. Now, as he resists demands to cut the benchmark interest rate, the faultfinding, some from former Fed policy makers, has escalated to charges that he's behind in the game and losing his credibility and effectiveness.

``This is a make-or-break moment for Bernanke,'' says David M. Jones, a former Fed economist who has written books on the central bank. ``It is an early and maybe ultimate test'' for the Fed chairman, who finds himself in ``a position of weakness, not strength.''

Bernanke, 53, hasn't made any public comments since July. He'll break his silence with a speech on housing and monetary policy Aug. 31 at the Fed's annual retreat-cum-symposium in Jackson Hole, Wyoming, before central bankers and economists from around the world.

`Oblivious to Pain'

The Fed Aug. 17 cut the cost of direct loans to banks and revised its economic outlook, opening the door to lowering the benchmark interest rate. Before that, ``there was this growing sense that he was oblivious to the pain in the marketplace,'' says Lehman Brothers Holdings Inc. chief U.S. economist Ethan Harris.

``Monetary policy is very much about confidence,'' says Harris, a former New York Fed official who'll be in the audience when Bernanke speaks. ``If the Fed doesn't unfreeze the markets, we'll have a recession, but also reputationally it's important'' for Bernanke.

Bernanke's performance in a crisis is being compared with that of his predecessor, Alan Greenspan, whose make-or-break moment came less than three months into his chairmanship. When stocks crashed in 1987, Greenspan pumped out money to help the economy rebound, bolstering credentials that some politicians had doubted. ``That was an extraordinary baptism of fire,'' Greenspan, 81, said this year.

Greenspan's Experience

Greenspan was a respected economic forecaster before joining the Fed and was well-known in Washington, having served as an adviser to Presidents Richard M. Nixon and Gerald R. Ford. He often based his economic outlook on his own research and experience. Bernanke, a former Princeton University professor, came to the Fed without Greenspan's Washington experience and relies more on economic models and forecasts to guide his views.

Bernanke has weathered criticism before. As a Fed governor in 2002, he earned the title of ``Helicopter Ben'' when he said the Fed would do everything necessary to fight a deflationary slump, a strategy he compared to a ``helicopter drop'' of money.

As chairman in April 2006, Bernanke said the Fed might pause from raising rates even if economic risks were still tilted toward inflation. His candor made him appear soft on inflation to some bond investors.

Those incidents pale beside the pressure Bernanke faces now, in the most tumultuous month of his tenure.

On Aug. 7, Bernanke and the Federal Open Market Committee voted at their regular session to reiterate that inflation was their main concern, while acknowledging increased economic risks. Three days later, the Fed pumped $38 billion into the banking system -- the most since after the 2001 terrorist attacks -- in its first effort to contain the credit crunch.

Unprecedented Steps

The following week, with borrowing continuing to dry up, the Fed took steps unprecedented in recent years: It cut the rate on direct loans to banks while issuing a revised outlook that acknowledged economic risks had risen ``appreciably'' and omitted any mention of inflation.

While some of the turmoil subsided, many financial-market participants clamored for Bernanke to follow the discount-rate cut with an immediate reduction in the benchmark federal funds rate to stimulate the economy.

His defenders say Bernanke's decision to stop raising interest rates a year ago ultimately proved correct, and so will his policies now.

Bernanke's Defenders

One who'll speak up for Bernanke's approach at Jackson Hole is Stanford University economist John Taylor, a former Treasury official. The Fed has made ``good decisions'' in the past two weeks, he said in an interview.

Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh, agrees: ``Bernanke's handled this very well, despite some hysterical cries on Wall Street.''

``He's been very balanced, setting up the possibility of a fed funds cut, but for the right reasons,'' Hoffman says.

Bernanke's academic work, which includes a study of the Fed's role during the Great Depression, equips him well to deal with the current crisis, says Lyle Gramley, a former Fed governor and now senior economic adviser to the Stanford Group Co. in Washington.

``The economist who has done the seminal work on the impact of credit crunches on the economy is named Ben S. Bernanke,'' says Gramley, 80, who'll also be at Jackson Hole. ``He's well aware of the fact that this situation could pose serious downside risks for the U.S. economy. His views are the ones that are going to ultimately prevail.''

Even so, criticism of Bernanke continues to mount, including an unusual public airing from former Fed policy makers.

Former Policy Makers

Former Fed governor Wayne Angell, 77, wrote an opinion column in the Aug. 23 Wall Street Journal calling for a cut in the federal funds rate and saying the central bank ``will continue to fall behind'' if it waits for more evidence of an economic slowdown.

``What the Fed did was too slow, and maybe it's because they're too cloistered,'' Martha Seger, 75, a Fed governor from 1984 to 1991, said in an interview. ``They're out of touch with what's going on in the real world. The problems that are out there go way beyond Wall Street.''

And former Dallas Fed President Robert McTeer, 64, said in an interview that he disagreed with the Fed's Aug. 7 view that inflation was still the ``predominant'' concern.

Some members of Congress are joining in.

`More Assertive'

Senator Sherrod Brown, an Ohio Democrat who serves on the Banking Committee, said in an interview that he wishes Bernanke had been ``a bit more assertive and aggressive on pre-empting much of this and in fixing what he can.''

Barney Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, wants to discuss the issue after returning from Congress's August recess: He is convening a hearing on the market turmoil Sept. 5 with Fed and Treasury officials.

Frank said in an interview he continues to believe Bernanke ``is as good as we could have gotten from this administration.'' Still, Frank says, ``I am troubled that he is too much of an `inflation-is-the-only-issue' chairman.''

Senate Banking Committee Chairman Chris Dodd, a Connecticut Democrat, summoned Bernanke and Treasury Secretary Henry Paulson to an hour-long meeting Aug. 21 and said Bernanke had agreed to use ``all of the tools at his disposal'' to restore stability in financial markets.

When he speaks, Bernanke may end up disappointing investors who are looking for fresh guidance on Fed policy.

Bernanke will ``say absolutely nothing about what the Fed might do,'' said former Fed vice chairman Alice Rivlin, 76, now a senior fellow at the Brookings Institution in Washington. ``He just wants to make everybody feel that the Fed is in good hands and that he is in charge.''

Muto Is Less Likely to Replace Fukui as BOJ Chief (Update1)

 
By Mayumi Otsuma


Aug. 27 (Bloomberg) -- Bank of Japan deputy chief Toshiro Muto is less likely to become the next governor since the opposition won last month's election, casting doubt on the central bank's policy of gradually raising interest rates.

The number of economists predicting Muto will replace Toshihiko Fukui, whose five-year term expires in March, dropped to eight out of 15 last week from all 15 in June, according to Bloomberg News surveys.

The opposition Democratic Party of Japan's control of the Upper House allows it to block nominations for the job. That could reduce Muto's chances and increase those of someone who might break from Fukui's plans to increase borrowing costs. The DPJ disapproved of Muto's appointment as deputy governor in 2003, citing his background at the Finance Ministry.

``If the DPJ sticks to its argument, the possibility of Mr. Muto becoming the central bank chief would be low,'' said Mamoru Yamazaki, chief economist at RBS Securities Japan Ltd. in Tokyo. ``But he still has a chance; whether he can win the trust of the DPJ by March will be key.''

Muto, 64, formerly the Finance Ministry's top official, has said the bank needs to raise rates gradually as the world's second-largest economy expands, signaling he'd continue Fukui's policy if selected.

The Cabinet's nominations of the governor and two deputies require the approval of both houses of parliament, according to the Bank of Japan Law. The Democrats oppose the practice in Japan of bureaucrats landing new senior positions at public and private institutions after their retirement.

Reluctant Support

The party's Secretary General Yukio Hatoyama and Vice President Naoto Kan suggested after the election that they would be reluctant to support Muto should he be nominated.

Hatoyama recently softened his stance, telling reporters on Aug. 10 that the party ``doesn't automatically negate'' the possibility of choosing Muto and it wants to hold a public hearing of candidates.

``Any signs that the DPJ may accept Mr. Muto's nomination means a lot,'' said Akio Makabe, a professor of economics at Shinshu University in Nagano, central Japan.

The Democrats' election win boosted the chances for Kazuo Ueda, a Tokyo University professor who sat on the bank's policy board for seven years through 2005. Six analysts surveyed said Ueda, 55, is now the most likely candidate.

In response to a question asking economists to list three potential nominees, Ueda was mentioned 14 times and Muto 12.

Ueda's Dissent

Ueda dissented when the central bank raised rates from near zero in August 2000, judging that the economy was too weak to withstand tighter credit. The bank cut borrowing costs seven months later as the global economy faltered. He told the Nikkei newspaper in May that Japan has yet to beat deflation.

``The pace of Japan's interest-rate hikes would probably slow if Mr. Ueda becomes governor,'' RBS's Yamazaki said. ``Investors would adjust their outlook for rates accordingly.''

The central bank last week kept the key overnight lending rate at 0.5 percent, the lowest among major economies, after global financial-market turmoil clouded Japan's growth prospects.

Fukui told reporters after the decision that keeping borrowing costs too low may spur risky investments. The bank will make an appropriate judgment by examining ensuing data and market movements, he said. The bank raised rates for the first time in almost six years in July 2006 and again in February.

Investors see a 36 percent chance policy makers will raise the key rate at the Sept. 18-19 board meeting, according to Credit Suisse Group calculations based on interest payments.

Less Willing

The ruling Liberal Democratic Party's election rout may make the government less willing to comment on the bank's policy, economists said. Prime Minister Shinzo Abe is expected to announce a Cabinet reshuffle today.

LDP Secretary General Hidenao Nakagawa, a critic of Fukui's pursuit of higher interest rates, last month said he would resign to assume responsibility for the election defeat. The government should study the effect of the two rate increases on economic growth, he said last week.

``The DPJ's advance may make it easier for the Bank of Japan to go ahead with policy it considers to be appropriate,'' said Teizo Taya, a former central bank board member and now adviser to the Daiwa Institute of Research in Tokyo.

Others the economists mentioned as potential candidates included Muto's fellow deputy Kazumasa Iwata, former deputy Yutaka Yamaguchi, ex-board member Nobuyuki Nakahara and former executive director Minoru Masubushi.

Those listed from outside the bank included Eisuke Sakakibara, a former vice finance minister for international affairs, Hiroshi Okuda, former chairman of Toyota Motor Corp., and Hiroshi Yoshikawa, a Tokyo University professor.

Consumer Spending Gains, Home Sales Fall: U.S. Economy Preview

 
By Joe Richter

Aug. 26 (Bloomberg) -- Consumer spending in the U.S. picked up in July while home sales fell, a sign income gains are sustaining demand even as the housing recession deepens, economists said before reports this week.

Personal spending increased 0.3 percent last month, three times the gain in June, according to the median forecast of economists surveyed by Bloomberg News before a Commerce Department report. Purchases of previously owned homes probably fell to an annual rate of 5.70 million, the fewest since October 2002, according to the survey.

The labor market has so far been strong enough to prevent a collapse in spending, softening the blow to the economy from a drop in home values and a widening credit crunch. Even with a resilient consumer, Federal Reserve policy makers said on Aug. 17 that ``downside risks to growth have increased appreciably,'' increasing speculation they will cut interest rates next month.

``The consumer is slowing but still healthy,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York. ``There's now tightening in many credit markets and it's harder to borrow, so the Fed is worried about a broad-based slowing in the economy rather than a housing-centric slowdown.''

The spending report, due Aug. 31, may show incomes rose 0.3 percent after a 0.4 percent gain in June, according to the median estimate of economists surveyed by Bloomberg.

The report's price gauge tied to spending patterns and excluding food and energy costs, the Fed's preferred measure, probably rose 2 percent from July 2006, up from 1.9 percent in June, which was the smallest 12-month increase since 2004.

Fifth Decline

The forecast decline in sales of previously owned homes would be the fifth straight drop reported by the National Association of Realtors. The figures are expected tomorrow.

Higher borrowing costs and stricter lending standards are making it more difficult to qualify for loans, causing a rise in the number of unsold homes and pulling prices lower.

A report the following day may show declines in home prices in 20 U.S. metropolitan areas during June. The S&P/Case-Shiller index has fallen every month this year.

``We continue to wrestle with the interrelated challenges of softer demand and excess housing supply in most markets,'' Robert Toll, chief executive officer of Toll Brothers Inc., said in a statement last week. Toll is the largest U.S. luxury homebuilder.

Subprime Fallout

Lenders and many borrowers are under increasing strain as the fallout from the collapse of the subprime mortgage market spreads. Mortgage applications fell 5.5 percent in the week ended Aug. 18, according to the Mortgage Bankers Association.

The crisis is compounding consumer concerns about falling home values and elevated energy costs. Sentiment among U.S. consumers dropped in August to the lowest level in a year, according to an Aug. 17 report from the University of Michigan.

A similar report from the New York-based Conference Board on Aug. 28 may show confidence among Americans this month was the lowest in a year.

The Fed cut the rate on direct loans to banks this month, trying to increase liquidity as investors avoid assets linked to subprime mortgages. Fed officials left the benchmark federal funds rate unchanged at 5.25 percent.

The Fed's view that downside risks had grown may have signaled a reversal from its Aug. 7 outlook that inflation was the greatest risk. Minutes of the Federal Open Market Committee's most recent meeting will be released on Aug. 28.

Bets on Fed Cut

Interest-rate futures on Aug. 24 showed traders reduced bets that the Fed will lower its overnight lending rate between banks by a half-percentage point to 4.75 percent by its Sept. 18 meeting. Futures showed a 60 percent chance of a cut to 5 percent, compared with 40 percent odds a week earlier. Forty percent were betting on a cut to a 4.75 percent funds rate by then, down from 60 percent the prior week.

A Bloomberg survey of economists, taken Aug. 1 to Aug. 8, forecast consumer spending to rise at a 2.3 percent pace in the third quarter after a 1.3 percent pace in the second quarter.

Some retailers lowered earnings estimates this month, raising concern that the consumer may have lost steam since that survey was taken, economists said.

Wal-Mart Stores Inc. and Home Depot Inc., the two largest U.S. retailers, on Aug. 14 said the housing slump, rising mortgage defaults and high energy prices will depress earnings for the year.

General Motors Corp., the biggest U.S. automaker, is trimming production at six North American plants that make large pickup trucks and sport-utility vehicles to clear dealer lots of excess inventory.

`Modest' Impact

Still, Fed Vice Chairman Donald Kohn said Aug. 19 that the effect of the subprime-mortgage crisis on U.S. consumer spending will likely be ``modest,'' though there's risk of a bigger slump.

Retailers Target Corp. and Saks Inc. said last week that sales will rise this year on the success of higher-margin designer goods.

On Aug. 30, the government will issue the second of three estimates of second-quarter growth. A narrower trade gap in June probably pushed up growth during the quarter to a 4.1 percent annual rate, compared with the 3.4 percent pace the government estimated on July 27.

Figures the following day from the National Association of Purchasing Management-Chicago will show business activity this month expanded at a pace similar to July, while a government report will show a second straight gain in factory orders, economists said.

Trichet May Keep Options Open as Investors Look for Rate Signal

 
By Simon Kennedy

Aug. 26 (Bloomberg) -- European Central Bank President Jean- Claude Trichet may buy time tomorrow as he seeks to thaw a credit-market freeze without surrendering a two-year fight against inflation.

In his first speech since the financial-market rout began, Trichet may disappoint investors wanting a clear signal whether he will raise interest rates on Sept. 6. He may instead keep his options open, pledging liquidity to the banking system without closing the door on an increase. He speaks at 3 p.m. in Budapest.

``The ECB is far from decided,'' said Michael Hume, chief European economist at Lehman Brothers Holdings Inc. in London. Trichet's speech ``seems too soon to clarify matters.''

A week ago, investors bet that the global contraction in credit would prevent the ECB lifting its benchmark rate from 4 percent. That view is now in doubt after the ECB on Aug. 22 loaned an additional 40 billion euros ($55 billion) to banks and said it was sticking to the policy stance expressed by Trichet on Aug. 2. Then, he promised ``strong vigilance,'' a phrase used to foreshadow each of the eight rate increases since 2005.

Investors reacted by reviving their wagers that the ECB will boost borrowing costs by a quarter point in September. The implied rate on the September interest-rate futures contract rose to 4.57 percent last week from 4.34 percent on Aug. 10.

Forecasts Abandoned

At the same time, some economists have scrapped their forecasts for further ECB tightening.

``Additional tightening from the ECB now risks exacerbating the current crisis and could prompt an even sharper slowdown,'' said James Nixon, an economist at Societe Generale SA in London who used to work as a forecaster at the ECB. ``We now expect the ECB to hold rates at 4 percent until at least the spring of next year.''

There is evidence that the fallout from the collapse in the American market for subprime mortgages is hurting Europe.

BNP Paribas SA, France's biggest bank, was forced to halt withdrawals from three of its investment funds, while Landesbank Sachsen Girozentrale, the German state-owned bank, is getting emergency funding.

UBS AG, Europe's largest lender, said Aug. 14 profit may decline for the rest of the year because of turmoil in financial markets. On Aug. 15, Merrill Lynch & Co. equity analysts cut their rating on Deutsche Bank AG, saying the squeeze in credit markets will reduce earnings.

`Deep Thinking'

The French and Italian finance ministries have urged Trichet to keep rates unchanged.

``We've had a severe deficit of confidence that fueled a liquidity shortage, which will in turn reduce the amount and terms of credit to companies,'' French Finance Minister Christine Lagarde said in an Aug. 24 interview. ``There has to be deep thinking about what is really taking place.''

Whether Trichet, 65, follows through with his August plan to raise borrowing costs will depend on how successful he is in calming market turbulence and ensuring it doesn't curb economic growth. The euro-region economy slowed more than forecast in the second quarter, and a report last week showed manufacturing and services growth slackened in August.

The ECB is already using other tools to smooth inter-bank lending, extending loans and adding 211.3 billion euros of extra cash to the money market between Aug. 9 and Aug. 14.

Should these operations ease investors' concerns, Trichet may be able to keep fighting inflation, said Marco Annunziata, chief economist at UniCredit Markets & Investment Banking in London.

`Crucial Distinction'

The ECB is ``highlighting a crucial distinction: While they are injecting liquidity as a short-term tactical move, their strategic policy stance does not necessarily change,'' Annunziata said.

Robert Lind, chief economist at ABN Amro Holding NV in London, sees reasons for the bank to lift rates regardless of the market rout: Growth remains above potential, spare capacity is shrinking and inflation is likely to accelerate above the ECB's 2 percent limit.

Trichet may also be worried about giving the impression he is prepared to alter monetary policy to rescue investors from risky wagers that went wrong, said Lind. ``The ECB will want to push rates to a more restrictive setting,'' he said.

Trichet has already given himself room to maneuver by noting on Aug. 2 that the council ``never pre-commits'' on rate shifts. Jim O'Neill, chief economist at Goldman Sachs Group Inc. in London, says he'll try not to close off any policy options tomorrow.

``Trichet is quite experienced in crisis management,'' he said. ``He's arguably the most experienced central banker in the world, so he should be able to find the right phraseology.''