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A Forecast of the Bank of Japan's Short-Term Economic Survey ("Tankan") (June Survey)

June 16, 2006

Business sentiment DI treading water due to poor weather and softer share prices

With production activity at a historic high, the business sentiment diffusion index (DI) for June is likely to see a rebound among large companies in the manufacturing sector, in reaction to the slight dip recorded in March.
In other sectors, however, the fact that it has not been possible to pass on a sufficient proportion of the rise in raw material costs to sales prices, and the poor weather this spring, which kept more shoppers at home and led to slow sales of seasonal goods, among other factors, make it likely that the DI will be unchanged or see a slight downturn.
On an all industries/all sizes of company basis, the DI is likely to be +5, on a par with the level recorded in the March survey.

Even if the negative impact of weather factors tails off, the "Forecast" DI, for the period to September 2006 is highly likely to reflect a cautious stance across a wide range of industries. On an all industries/all sizes of company basis, the "Forecast" DI is likely to be around +3, 2 points down on the "Actual" DI for June.
The main factors are as follows:
(i) The need to ascertain the trends of domestic and overseas share prices, which have been softening since May, and their impact on the real economy (especially household consumption).
(ii) The likelihood that the US economy will see a slight deceleration, largely due to a slowdown of the growth in housing prices.
(iii) The fact that, as market competition, fanned by the growth of imports growth, remains intense and the recovery potential of wages is extremely low, it is still difficult to pass on the increase in the price of raw materials to sales prices.

Thus, the June Tankan is likely to show corporate confidence treading water at present.
However, owing to the alleviation of a range of pressures for structural adjustment and the availability of a plentiful stock of money, the corporate sector is becoming more "shock-resistant".
Under these conditions, it is unlikely that the expansion of capital investment and employment (with a view to surviving global competition and counteracting the mass retirement of the dankai generation of baby boomers and the onset of full-scale population decline) will collapse sooner or later, or even that the economy will falter.
If share prices gradually recover their stability, on the assumption that corporate activity sees a steady expansion and political disorder is avoided, it is thought likely that the upward trend of the business sentiment DI will continue in the September Tankan.

FY 2006 capital investment plans: June figures likely to show growth at around the same pace as in FY 2005

In fiscal 2006, with structural adjustments being completed and a growing number of companies shifting to a more "aggressive" management stance based on a medium-to-long term outlook, it is likely that capital investment plans will continue to grow, incorporating a greater proportion of projects relating to objectives of a highly "stand-alone" nature, such as "moving into new businesses", "increasing added value" and "research & development".
On an all industries/all sizes of company basis, including land but excluding software, the June Tankan is likely to reveal that capital investment plans for fiscal 2006 are up 5.6% on the previous fiscal year, approximately the same rate of growth (5.4%) as recorded with respect to plans for fiscal 2005 in June last year.

Enhancing shareholder value by increasing capital efficiency is becoming a key management issue, and, depending on the extent to which the US economy decelerates and on the trend of domestic and overseas share prices, it is possible that companies will adopt a flexible approach, for example by postponing investment, especially with regard to projects relating to "increasing capacity".
However, given that capital investment plans are growing and that their scope is growing both across industries and purposes, and given the availability of a plentiful stock of money, the risk that capital investment will see a substantial downturn is slight.
Consequently, it is highly likely that capital investment will continue to be an "engine of growth" for some time.

Inquiries relating to the content of this report, etc. should be addressed to Ishikawa , Economics Department, the Japan Research Institute, Limited.

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

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