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Forecast of GDP Statistics for the April-June Quarter of 2006

June 31, 2006

April-June quarter set to see annualized growth of 1.6%

Statistics for the April-June quarter of 2006 (first preliminary QE due to be published on August 11) are likely to show that Japan's GDP increased by 0.4% on the previous quarter (equivalent to an annualized rate of +1.6%). Although this will be the sixth consecutive quarterly rise, the statistics are likely to show that quarter-on-quarter growth has slowed from the +1.1% recorded in the October-December quarter of 2005 and the +0.8% recorded in the January-March quarter of this year.

The major reasons for the slowing of the pace of economic growth are sluggish consumer spending as a result of poor weather and a slowdown in exports centering on shipments to Asia (excluding China) and the United States.
Nevertheless, supported by firm capital investment, the economy has managed growth on the same quarter of the previous year in the mid 2-3% range (+2.6%).
Accordingly, the developments of the April-June quarter could be interpreted as "a speed adjustment as part of economic growth slowing from the rapid pace recorded in the second half of fiscal 2005 to a more sustainable pace".

Movements of the major elements of demand and the GDP deflator

(1) Consumer spending (real: +0.3% on previous quarter, +1.1% annualized)

After the strong growth recorded during fiscal 2005, consumer spending appears to have slowed. This is largely due to sluggish sales of summer goods, with customers staying away from stores owing to climatic factors including lower temperatures than last year and a concentration of rainfall at weekends. It is also possible that the instability of share prices has made consumers more cautious and curbed their propensity to spend.
However, the steady improvement in employee incomes has continued and the growth of consumer spending itself has continued.

(2) Capital investment (real: +1.3% on previous quarter, +5.3% annualized)

The statistics are set to show a quarter-on-quarter rise for a ninth consecutive quarter. The impact of the reaction to the double-digit annualized growth recorded in the January-March quarter is likely to have been limited as companies have been raising their expected growth rates and shifting their medium-term management stance from "backward-looking adjustment" to "aggressive business development with a view to survival in a climate of global competition".
Incidentally, closer examination of theplans of major corporations intending to implement large-scale capital investment or a substantial increase in capital investment in fiscal 2006 reveals that they are characterized by (i) "selection and concentration" of business activities into high value-added areas and (ii) increased investment with a view to the development and fostering of new businesses.Moreover, in the manufacturing sector, there have been moves to increase production capacity for LC-related products.

(3) Exports (real: +0.5% on previous quarter, +2.2% annualized)

The statistics are likely to show that exports have risen quarter-on-quarter for a fifth consecutive quarter, but that the rate of growth has slowed sharply. This is largely due to (i) sluggish growth of shipments to the United States, especially of electrical equipment for household use (audio-visual equipment, consumer electronics, etc.) and automobiles, and (ii) a quarter-on-quarter fall in shipments to Asia (excluding China), especially of electronic devices and material products.
The US economy is showing signs of deceleration, and it appears that the downward pressure on exports has started to affect not only shipments of final goods intended for the local market but also shipments of intermediate goods to overseas production bases.

However, exports to China, especially shipments of final goods, remain strong, and the growth of exports to the EU, especially shipments of capital goods, accelerated in the April-June quarter. Overall, exports continue to grow.

(4) GDP deflator (change on same quarter in previous year: –0.9 %)

The statistics are likely to show that the year-on-year rate decline in the GDP deflator has slowed by 0.3 points since the January-March quarter. Although the double-digit growth of the import deflator has continued (+11.5% on the same quarter in the previous year, exerting downward pressure on the GDP deflator), the consumer spending deflator saw its first year-on-year rise since the October-December quarter of 1998 (+0.2%), leading to a slowing of the overall decline. The domestic demand deflator turned positive for the first time since the October-December quarter of 2004 (+0.1%).

However, one reason for the rise in the consumer spending deflator is that poor weather contributed to a rise in the price of fresh foods. The movement to pass on to sales prices the rise in procurement costs triggered by the rise in natural resource prices is not yet widespread.

Looking to the future, the adjustment in the speed of economic growth against the background of the deceleration of the US economy, the rise in the price of crude oil and the slow recovery of wages is likely to continue for some time. Moreover, if share prices remain close to their present level, the asset effect on consumer spending in fiscal 2006 will be slighter than that recorded in fiscal 2005, and it is possible that the negative impact of the increase in the various burdens on the household sector will become apparent.

However, given the improving balance of shipments and inventory in the materials sector and the alleviation of a range of pressures for structural adjustment, the Japanese economy is likely to retain a considerable ability to absorb shocks (a different scenario from that which occurred during the "plateau" phase of 2004, at the time of the collapse of the high-tech bubble). Under these conditions, it is unlikely that the economic recovery centering on employment and capital investment will collapse.
It seems highly likely that the economy will continue to renew its record for the duration of a growth phase (outlasting the "Izanagi Boom").

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

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