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Revised Economic Forecast for Fiscal 2006-2007
(Subsequent to Release of 2nd Preliminary QE for April-June)

Sep 12, 2006

The 2nd Preliminary Quarterly Estimates for April-June 2006, released by the Cabinet Office onSeptember 11, forecast real GDP growth on the previous quarter equivalent to an annualized rate of +1.0%, a small upward adjustment as compared with the +0.8% estimated in the 1st Preliminary QE.
A breakdown by major elements of demand reveals that substantial upward adjustments of private sector investment in inventory has made a major contribution to the overall upward revision (contribution to real annualized growth on previous quarterrevised upwards from –0.9 points in the 1st Preliminary QE to –0.1 points, to reflect the content of the April-June Financial Statements Statistics of Corporations by Industry, Quarterly). Meanwhile, the estimate of public investment has been revised downwards (contribution to real annualized growth on previous quarterrevised downwards from –17.1% to –22.8%, to reflect the content of the June construction statistics).
Following fresh seasonal adjustment, the January-March figures for private sector investment in inventory have also been revised upwards (contribution to real annualized growth on previous quarterrevised upwards from +0.2 points to +0.8 points). As a result, the "carry-over" effect or the January-March quarter on real economic growth in fiscal 2006 has risen by +0.13 points in the 1st Preliminary QE to +1.31 points.

Figures for the other elements of demand are approximately the same as those of the 1st Preliminary QE.

The basic scenario is unchanged: although the growth rate is likely to slow as a result of the slowdown in exports to the United States and Asia and the substantial fall in public investment, domestic private sector demand will basically remain steady, with capital investment rising and consumer spending, especially on services, holding firm.

The Institute's growth forecast subsequent to the release of the 2nd Preliminary QE is as follows. The forecast for the overall course of growth is unchanged, but, owing to the upward revision of the "carry-over" effect among other factors, the forecasts of real and nominal growth for fiscal 2006 have both been revisedupwards by 0.1 points, as compared with those published in August.
The growth forecasts for fiscal 2007 are basically unchanged.
The pace of growth in the July-September quarter is likely to exceed that recorded in the April-June quarter, owing largely to a reaction to the rapid fall in demand form the government sector.

In the short term, however, owing to the slowdown in the US economy, the continuing high cost of natural resources, and the slow recovery in wages, the economy is likely to enter a gentle deceleration phase.

Moreover, stocks of electronic components and devices are growing rapidly, and if the results of the end-of-year sales campaigns in Japan and overseas fail to come up to expectations, there is a risk that pressure for adjustment will surface in the IT sector, early in 2007.

Nevertheless, two factors suggest that, in contrast to the situation during the "plateau" phase of 2004 or at the time of the collapse of the high-tech bubble,the Japanese economy retains a considerable ability to absorb shocks:

(i) The shipments-inventory balance in non-IT sectors is improving.
Even if pressure for adjustments arises in the IT sector, the non-IT sectors willunderpin demand and it is likely that a major production adjustment across all sectors of industry can be avoided.

(ii) The corporate sector is resolving pressures for structural adjustment and is likely to enjoy plentiful money stocks.
With management concerns in the corporate sector shifting from the "adjustment of excessive levels of employment, capital equipment and debt" to "active business development with a view to survival against global competition" and "securing human resources in anticipation of the retirement of the dankai baby-boomer generation and full-scale population decline, there is little risk that the upward trend of capital investment and employment will falter in the short term.

Thus, in fiscal 2006, it is likely that the economy will continue to renew its record for the duration of a growth phase (outlasting the "Izanagi Boom") while adjusting its speed towards a sustainable growth trajectory.The growth rate for fiscal 2006 as a whole is likely to remain at around 2.3%, lower than the rate of 3.2% recorded in fiscal 2005, but somewhat higher than the likely latent growth rate, which is expected to be between 1.5% and 2.0%.

In fiscal 2007, the recovery of the US economy and the boost to corporate profits provided by the mass retirement of dankai generation baby boomers (through increased consumer spending on the strength of a rise in the payment of lump sum retirement benefits and through a fall in personnel costs) will have an increasingly positive effect on the economy. Under these conditions, it is highly likely that the growth rate will accelerate once more as the second half of the fiscal year begins, and that growth for the fiscal year as a whole will reach the middle of the 2-3% range.

Consumer prices (excluding fresh foods, year-on-year change) are likely to settle into a positive trend as the balance of supply and demand improves. However, a number of factors, including intense market competition, the low recovery potential of wages and a year-on-year slowdown in the growth of natural resource prices, mean that there is little likelihood of an acceleration of the rate of increase in consumer prices.

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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