Japan's Economy Contracts a More-Than-Expected 1.2% (Update3)

 By Lily Nonomiya


Sept. 10 (Bloomberg) -- Japan's economy contracted at almost twice the pace forecast by analysts in the second quarter, hardening speculation the central bank will refrain from raising interest rates 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 result was less than the government's initial estimate for a 0.5 percent expansion.

Bond yields fell to the lowest level since February last year and the benchmark Nikkei 225 stock average slumped more than 2 percent. Any rebound in growth depends on the severity of the housing recession in the U.S., Japan's biggest export market.

``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 9:39 a.m. in Tokyo. The Nikkei 225 tumbled 2.7 percent. The yen traded at 112.92 per dollar from 113 before the report was published.

The 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 quarter.

Capital Investment

Capital investment declined 1.2 percent, reflecting last week's report that showed spending by companies unexpectedly declined in the quarter. Spending by consumers was revised to show a 0.3 percent increase, lower than the initial estimate for a 0.4 percent gain. Public investment was revised to a 2.6 percent drop from the previous estimate for a 2.1 percent slide.

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.

Federal Reserve

``A September increase is very unlikely as the BOJ won't want to tighten policy at a time when global market stability is a top priority,'' said Hideo Kumano, a senior economist at Dai- Ichi Life Research Institute and a former BOJ official. ``They especially wouldn't want to raise rates a day after the Fed cuts them.''

Since July, 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.

Japan's economic expansion has cooled since growth surged at a 5.4 percent clip in the fourth quarter, the fastest pace in two years.

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

Weak Rebound

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

Japan's broadest indicator of the outlook for growth was 70 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.

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.

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

``My scenario is Japan's economy gets better from here as industrial production picks up,'' said Masamichi Adachi, an economist at JPMorgan Securities Japan Co. in Tokyo.

Global Growth Threatened as U.S. Contagion Infects Asia, Europe

 By Rich Miller


Sept. 10 (Bloomberg) -- This time, when the U.S. sneezes, the rest of the world may well catch a cold.

Global economic growth looks likely to slow markedly in the months ahead as further weakness in the U.S. infects Asia and Europe. That would represent a shift from the last 18 months, when the world economy proved immune to a U.S. slowdown and grew at an annual clip of more than 5 percent.

What's different now is the U.S. slump is starting to spread from the domestic housing market to consumers who buy imports from companies such as Toyota Motor Corp. And the sudden increase in borrowing costs that followed the collapse of the subprime-mortgage market is now showing up overseas, raising the price tag on credit worldwide.

``It will be a much bigger deal this time,'' says Raghuram Rajan, a former chief economist for the International Monetary Fund who's now a professor at the University of Chicago. ``I don't see growth falling off a cliff, but it will slow.''

If growth in the U.S. slips below 2 percent from an average of 2.3 percent in the first half, the global economy may suffer a modest slowdown to about 4.75 percent, say forecasters at Morgan Stanley & Co., Global Insight and the Economist Intelligence Unit. The contagion from a U.S. recession would hurt more, cutting global growth to 3.5 percent or less.

`Major Problem'

``If we have a major problem in the U.S., the rest of the world will feel an impact,'' says Otmar Issing, former chief economist of the European Central Bank.

Faced with an unsettled global outlook, central bankers in England, Europe, Canada, Australia and South Korea held back on raising interest rates last week. In the U.S., futures-market traders are betting that Federal Reserve Chairman Ben S. Bernanke and his colleagues will cut rates when they meet on Sept. 18.

The world economy is most at risk when a shock -- like the steep oil-price increases of the 1970s -- hits the U.S. and other nations simultaneously, according to an April IMF study. That's what seems to be happening now, as global investors and lenders turn more cautious in response to rising delinquencies on loans to borrowers with patchy credit.

To be sure, the world economy is stronger than it was when turmoil last struck credit markets a decade ago, driving much of Asia into recession.

Slower Growth

Still, there's agreement that global growth will suffer -- even among some prominent Wall Street proponents of the theory that the rest of the world can ``decouple'' from the U.S., including Jim O'Neill, chief economist at Goldman Sachs Group Inc., and Stephen Jen, head of foreign-exchange research for Morgan Stanley, both in London.

While Luxembourg Prime Minister and Finance Minister Jean- Claude Juncker doesn't see a ``major'' hit in 2007 for the 13 nations that use the euro, ``there could be a stronger impact'' next year, he told reporters Sept. 5. Juncker is the chairman of a panel of euro-zone finance ministers.

Even before the latest rise in borrowing costs, some of Europe's strongest housing markets were showing signs of weakness. Spanish home starts plunged 21 percent in May, virtually wiping out growth for the year, while Irish house prices suffered their first annual decline in at least a decade in July.

Qualceram Shires Plc, an Irish maker of ceramic bathroom sinks and toilets, said on Sept. 4 that its first-half profits fell 7.4 percent as cooling property markets in Ireland and the U.K. reduced sales.

Trouble Ahead

There could be further trouble ahead. U.K. lenders, including Merrill Lynch & Co.'s Mortgages Plc unit and Deutsche Bank AG, are tightening terms on home loans, raising the cost for borrowers with less-than-perfect credit ratings.

``The same person trying to get a mortgage will find the situation more difficult now than three months ago,'' says Fionnuala Earley, chief economist at Nationwide Building Society, the U.K.'s fifth-biggest home lender.

European companies also face higher costs as the region's banks become stingier with their money, says Adam Posen, a former Fed official who is now at the Peterson Institute for International Economics in Washington.

German business confidence fell to a 10-month low in August after a rise in the cost of credit, according to the Munich- based Ifo Institute for Economic Research.

Tighter Credit

While tighter credit will take a toll on Asia, the region's economies are even more vulnerable to a slowdown in U.S. demand for their products. Consumer spending, which accounts for about 70 percent of the U.S. economy, rose at an annual rate of 1.4 percent in the second quarter, its slowest pace in a year.

Asia is ``still heavily dependent on exports,'' Stephen Roach, chairman of Morgan Stanley in Asia, said in an interview on Sept. 6. ``And the largest market for most Asian economies remains the overly extended American consumer, who I think is the next shoe to drop in the subprime shake-out scenario.''

Some Asian countries are already feeling the impact. The growth of Thailand's exports slowed to an annual rate of about 6 percent in July and August from 18.1 percent in June. Malaysia's exports declined for a second straight month in July as waning U.S. demand reduced shipments of electrical and electronic goods.

Even China's booming economy is susceptible to a consumer- led slowdown. The U.S. is China's biggest single-nation trading partner, accounting for nearly one-fifth of its record $107.7 billion exports in July.

`Serious Risk'

``The rising probability of a U.S. recession and growing trade protectionism means China's export growth is at serious risk,'' Huang Yiping, chief Asia economist at Citigroup Inc. in Hong Kong, said in an Aug. 30 report to clients.

Faced with inflation at a 10-year high, China has raised interest rates and acted to curb bank lending to cool its overheated economy. Sun Mingchun, an economist for Lehman Brothers Holdings in Hong Kong, said in an Aug. 31 note that those concerns ``could be turned on their head if the global economy turns down sharply.''

Japan, Asia's biggest economy, is already showing signs of faltering. Gross domestic product probably shrank in the second quarter for the first time in more than two years as companies pared spending and exports failed to contribute to growth, economists surveyed by Bloomberg say.

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.

``There is a lack of confidence over where the economy is heading,'' Bob Carter, head of U.S. sales for the Toyota brand, said on Sept. 5. The Toyota City, Japan-based company ``would welcome'' a Fed interest-rate cut, he added.

Trichet, China's Zhou Say Credit Crisis Effects Limited So Far

 By Simone Meier and Tian Ying

Sept. 9 (Bloomberg) -- European Central Bank President Jean- Claude Trichet and People's Bank of China Governor Zhou Xiaochuan said the impact of credit-market turbulence has been limited so far, while expressing uncertainty about the outlook.

The prospects for growth in the economy of the 13 euro nations are ``still good'' although ``uncertainties are augmenting,'' Trichet told Italian television network RAI late Sept. 7. Zhou today in Basel, Switzerland said that China would ``experience some impact,'' if global growth were hurt by the credit crisis.

A global flight from risky assets that began last month has forced the ECB and other central banks to inject more than $400 billion of emergency funds into money markets on concern it may sap economic growth. U.S. employment unexpectedly fell in August for the first time in four years, prompting speculation the credit crunch is affecting the wider economy.

For now, central banks worldwide are refraining from raising rates as they assess how the credit squeeze will affect growth.

ECB council member Miguel Angel Fernandez Ordonez told reporters in Basel today that it's ``prudent'' to wait with interest-rate decisions in order to ``make an assessment of the current turmoil.'' Ordonez, like China's Zhou, was attending a regular meeting of the Bank for International Settlements.

About $139 billion of commercial paper falls due in the next 10 days, Britain's Sunday Telegraph newspaper reported today, citing David Brickman, head of European credit strategy at Lehman Brothers Holdings Inc.

Commercial Paper

As much as $46 billion of the notes mature on Sept. 17 alone and banks have been stockpiling cash in preparation, causing credit markets to seize up, the London-based newspaper said.

Commercial paper is sold in a variety of maturities of 270 days or less. The coming 10 days include a so-called double- rollover week, when quarterly loans expire along with shorter- term notes, which may exacerbate the crisis that has hit the money markets, the Telegraph said.

The ECB on Sept. 6 left its key rate at 4 percent, shelving a planned increase. The Bank of England the same day kept its main lending rate at 5.75 percent. Central banks in Indonesia, Australia and Canada also opted to keep their benchmark on hold last week. The Bank of Japan last month stepped back from plans to raise its key rate from 0.5 percent.

`Clear Recovery'

``Our central scenario remains one of a clear recovery,'' European Union Economic and Monetary Affairs Commissioner Joaquin Almunia said yesterday at a conference in Cernobbio, Italy. ``We have been monitoring the situation closely. It's too early to draw a conclusion.''

ECB Governing Council member Vitor Constancio told Portuguese TV station RTP1 yesterday the elements that will determine whether the turbulence affects the economy include the duration of the crisis and the scale of a U.S. slowdown. His Irish counterpart John Hurley said in Basel today that European ``growth is good, but there is a great deal of uncertainty.''

The ECB on Sept. 6 forecast the euro-region economy to expand about 2.5 percent this year and 2.3 percent in 2008. It previously had projected growth of about 2.6 percent this year. In 2006, the economy grew 2.7 percent, the fastest pace since the turn of the century.

For Europe, credit-market turmoil worsened Aug. 9 after BNP Paribas SA acknowledged its vulnerability to increasing defaults on U.S. subprime mortgages. Landesbank Baden-Wuerttemberg, Germany's largest state-owned bank, on Aug. 27 agreed to buy Landesbank Sachsen Girozentrale after the lender was bailed out.

China's `Exposure'

In China, financial institutions' ``exposure'' to the U.S. subprime mortgage crisis is ``not significant,'' Zhou said today. ``Unless the situation deteriorates,'' the impact of market turbulence on Chinese financial institutions and the economy is ``up to now estimated to be quite limited.''

Governors from the world's largest central banks including the U.S. Federal Reserve, the ECB, the Bank of Japan and the People's Bank of China meet every two months in Basel under the auspices of the Bank for International Settlements, the central bank of the world's central banks.

Consumers `Still in the Game,' Spend More: U.S. Economy Preview

 By Joe Richter

Sept. 9 (Bloomberg) -- Consumer spending picked up in August even as job losses and record home foreclosures threatened the U.S. economic expansion, economists said before a government report this week.

Sales at retailers rose 0.5 percent after a 0.3 percent increase the prior month, according to the median estimate in a Bloomberg News survey before the Commerce Department's Sept. 14 release. Other figures this week may show the trade deficit widened in July and imports prices cooled last month.

``The consumer was still in the game'' in August, said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh. ``There's going to be more hesitancy and spillover from housing in coming months that will temper economic growth, but the consumer is showing some resiliency.''

Rising wages have allowed spending, which makes up more than two-thirds of the economy, to hold up so far. That won't stop the Federal Reserve from cutting interest rates next week because falling home values and the first drop in payrolls in four years raise the risk that consumers will buckle, economists said.

Auto dealers led the increase in August sales, forecasts indicated. Cars and light trucks sold at an annual rate of 16.3 million last month, up from a July pace that was the weakest in almost two years, industry figures showed last week.

Retail sales excluding motor vehicles increased 0.2 percent following a 0.4 percent advance in July, the survey showed.

Economists predict that, while Americans have grown more concerned about declining home prices and the rising cost of credit, spending will probably slow rather than crumble.

Sales Top Estimates

Bentonville, Arkansas-based Wal-Mart Stores Inc. was among retailers that reported August sales topping analysts' estimates. Purchases of clothing and electronics for the new school year pushed sales up 2.9 percent, based on results from 47 retailers, the International Council of Shopping Centers said last week.

The Fed, in its regional report known as the Beige Book, said last week that, while tighter lending standards were having a ``noticeable effect on housing,'' the impact of the August credit-market rout on the broader economy was `limited.'' Retail sales were ``generally positive'' according to the survey, which concluded Aug. 27.

A softening labor market may spell bigger challenges for consumers and retailers ahead, economists said.

Employers unexpectedly cut 4,000 workers from payrolls in August, after a revised gain of 68,000 jobs in July that was smaller than previously reported, the Labor Department said Sept. 7. Average weekly earnings rose to $591.50 last month from $589.81 the prior month.

`Collateral Damage'

The drop in hiring is ``collateral damage from the disruptions we saw'' in financial markets last month, said Carl Tannenbaum, chief economist at LaSalle Bank in Chicago. ``The Fed will be very hard-pressed not to reduce rates.''

A Labor Department report Sept. 13 may show the total number of Americans receiving unemployment benefits jumped last week. First-time claims probably rose to 325,000 from 318,000 a week earlier, the survey showed.

A day later, the Reuters/University of Michigan preliminary consumer sentiment index for September will be little changed from the one-year low reached in August, economists said.

Fed Governor Randall Kroszner said Sept. 6 that the unraveling in mortgage lending may further erode demand for housing, ``with possible implications for the broader economy'' should the crisis persist. The Fed will ``act as needed'' to limit damage from financial market tumult, Chairman Ben S. Bernanke said Aug. 31.

Policy makers, who meet on Sept. 18, may get some help in fighting inflation from slowing import prices. Prices of goods shipped to the U.S. probably rose 0.2 percent in August after a 1.5 percent gain in July, economists said before a Sept. 14 report from the Labor Department. Moderating costs for imported commodities may signal a reduced inflation risk, giving the Fed leeway to lower rates, economists said.

Finally, a Sept. 11 report from the Commerce Department may show the trade deficit grew 1.5 percent to $59 billion in July from $58.1 billion in June, according to the median forecast.