First Preliminary QE for January-March set to Show Zero Growth; Upward Adjustment Expected From Second Preliminary QE Onwards

The GDP statistics for the January-March quarter of 2006 (first preliminary QE due to be published on May 19) are likely to record zero growth, with real economic growth running at 0.0% on the previous quarter or an annualized rate of +0.1%.

The major reasons for the slowing of the pace of economic growth in the January-March quarter are that (i) the reaction to the 5% annualized growth rate recorded in the October-December quarter of 2005 manifested itself largely in consumer spending, inventory investment and imports, and (ii) owing in part to the techniques used in compiling statistics, capital investment fell quarter-on-quarter for the first time in two years (since the January-March quarter of 2004).

The fact that average annualized level of quarter-on-quarter growth in the second half of fiscal 2005 (October-2005-March 2006) and growth in the October-December quarter of 2005 as compared with the same quarter of 2004 were both around +3% (respectively +2.9% and +3.1%) and the possibility that capital investment figures will be revised upwards following the release of the second preliminary QE (on June 12), which reflects a wider range of basic data, suggest that the slowdown recorded in the first preliminary QE is a temporary phenomenon and that the figures are likely to be revised upwards.

Movements of the Major Elements of Demand and the GDP Deflator

(1) Consumer Spending (real: +0.2% on previous quarter, +1.0% annualized)

Owing largely to climatic factors, the strong growth recorded during 2005 appears to have slowed. In late December 2005 and early January 2006, the coldest weather since the Second World War had a positive effect on consumer spending by boosting sales of winter clothing and heating equipment, but after the New Year, the positive effect tailed off and the cold spell exerted a downward pressure on consumer spending as a whole by curbing spending in areas such as leisure and eating out.
However, in view of the steady recovery of employee incomes and the healthy market for "high-value goods", the destabilization of share prices appears to have had a limited impact, and, in March, demand for leisure and eating out began to recover. These developments suggest that consumer spending has basically held firm.

(2) Capital Investment (real: –0.2% on previous quarter, –1.0% annualized)

The figures are likely to show that capital investment fell quarter-on-quarter for the first time since the January-March quarter of 2004 (the first time in 2 years). The boost provided by major redevelopment projects in city centers is tailing off and companies are considering measures such as mergers and acquisitions and with Japanese companies beginning to consider overseas investment and mergers & acquisitions as means of expanding their business, the pace of investment has slowed since the rapid growth recorded in the first half of fiscal 2005.
However, the figures for capital investment in the first preliminary QE are basically obtained by subtracting public investment and housing investment from "gross fixed capital formation", which is estimated on the basis of a range of supply statistics (production trend statistics, etc.). For this reason, figures often undergo a substantial upward revision in the second preliminary QE, which reflect the Financial Statements Statistics of Corporations and other statistics based directly on demand for capital investment. (Note, however, that the figures for the October-December quarter of 2005 were revised downwards from an annualized growth rate of 7.2% at the time of the first preliminary QE to 1.4% at the time of the second preliminary QE.)
Given that the March survey of the Bank of Japan's Short-Term Economic Survey (Tankan) suggests that expected capital investment for fiscal 2005 will see double-digit growth on fiscal 2004 (+11.3%), it is highly likely that capital investment figures will be revised upwards, in or after the second preliminary QE, and that the overall growth rate will see a corresponding rise.

(3) Net Exports (real: contribution to growth on previous quarter: +0.1 points, annualized contribution: +0.4 points)

The first preliminary QE are likely to show that exports have achieved double-digit annualized growth for a fourth quarter in succession (+3.0% quarter-on-quarter, +12.7% annualized). The growth of shipments to the United States has slowed to some extent, but the substantial growth of shipments to oil- and other resource-producing countries, centering on automobiles, has provided the momentum for overall growth. Shipments of capital goods to Asia (excluding China), which weakened at the end of 2005, are also recovering.
However, because imports, which fell quarter-on-quarter in the October-December quarter of 2005 have begun to grow once more (+3.0% quarter-on-quarter, +12.6% annualized), the contribution to economic growth made by net exports is likely to have seen a sharp fall as compared with the +2.3 points (annualized rate) recorded in the October-December quarter of 2005.

(4) GDP Deflator (change on same quarter in previous year: –1.1 points)

The first preliminary QE are likely to show that the year-on-year fall in the GDP deflator has slowed by 0.5 points since the October-December quarter of 2005. Although the import deflator has seen its largest rise since 1994 (the earliest year for which statistics are comparable; +15.0% on the same quarter in the previous year, pushing down the GDP deflator), the consumer spending deflator has seen its largest year-on-year increase (+0.2%) since the October-December quarter of 1998. Although the trend is as yet limited to a few areas such as fuel, there are signs that enterprises are beginning to pass on to their sales prices the rise in procurement costs triggered by the rise in raw material prices and it appears that this is helping to reduce the downward pressure on the GDP deflator that has accompanied the rise in raw material prices.

Looking to the future, the slight deceleration of the US economy, the fact that the pace of recovery of wages is likely to remain slow, and the fact that the rises in the price of crude oil and in long-term interest rates are bringing pressure to bear on corporate profits, are likely to restrict the pace of recovery in the short term.
However, as the pressure for structural adjustments diminishes and the economy's resistance to shocks increasing, it is unlikely that the virtuous circle whereby strong exports and capital investment boost corporate profits, bringing a recovery of employee incomes and a continued upward trend in share prices, which leads to a rise in demand from the household sector, which in turn boosts corporate profits still further will fail. Moreover, if share prices remain stable, this can be expected to continue to boost household expenditure.

Overall, the economy is likely to see a slow but sustained recovery. The real growth rate, which slowed in the January-March quarter will eventually recover and the average pace of growth is likely to be on a par with the latent growth rate (thought to be in the middle of the 1-2% range) or a little higher.

For more information on the content of this report, please contact: Makoto Ishikawa the Japan Research Institute, Limited.

Tel: 03-3288-4263
E-mail：ishikawa.makoto@jri.co.jp

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