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

Sep 15, 2006

Business sentiment DI: a slight improvement in recent months; outlook cautious

(1) In spite of the slowdown in the US economy and the fact that businesses have not been able to pass the rise in raw materials prices on to sales prices to a sufficient extent, the diffusion index (DI) for September is likely to show that business sentiment has held steady or improved slightly in every sector, on the strength of robust corporate activity (mining & manufacturing production, tertiary industry activity) against a background of steady expansion of domestic private sector demand. On an all industries/all sizes of company basis, the DI is likely to be +7, up 1 point on the level recorded in June.

(2) By contrast, the three factors outlined below make it highly likely that the "Forecast" DI for the period to December this year will indicate a cautious stance, especially in the manufacturing sector, and particularly among small and medium enterprises:
(i) The future direction of the US economy (the scale and duration of the slowdown) is uncertain.
(ii) In spite of a slight slowing in the growth of the commodity markets in recent months, market competition remains intense, and the slow pace of the recovery in wages makes it unlikely that the difficulty in passing the rise in raw materials prices on to sales prices will be easily resolved
(iii) With share prices slow to rise, there is little hope of a rise in share prices stimulating demand. On an all industries/all sizes of company basis, the "Forecast" DI is likely to be +5, up 2 points on the actual level for September.

(3) Thus, the September Tankan is likely to confirm once more that the improvement in business confidence has been a small one. However, 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 corporate sector retains a considerable ability to absorb shocks, making it unlikely that the economic recovery and the improvement in business confidence themselves will falter:

(i) The balance of shipments to inventory in non-IT sectors is improving.
In contrast to the IT sector, where the improvement seems to have peaked, the balance is improving in these sectors.
(ii) Pressures for structural adjustment are being resolved and the sector is enjoying plentiful money stocks.
There is little risk that the upward trend of capital investment and employment aimed at "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" will falter in the short term.

FY 2006 capital investment plans: September figures likely to show slightly faster growth than recorded in FY 2005

(1) Fiscal 2006 capital investment plans are likely to continue to grow, centering on projects that embody the shift towards "selection and concentration" into high value-added sectors and towards more "aggressive" business management with greater investment in the development of new businesses and in research & development.
Although machinery orders for July (private sector demand, excluding shipbuilding) were down 16.7% on the previous month's level, the change on the previous year for the April-July period was +11.5%. The growth of capital investment plans remains well above the average economic growth rate for fiscal 2005 (+5.6%).

(2) The overall adjustment to capital investment plans relative to the June figures in the September Tankan is likely to be small, although higher than in the average year, especially among small and medium enterprises. (On an all industries/all sizes of company basis, including land but excluding software, the adjustment was 1.3% in fiscal 2005 and 1.5% in fiscal 2004.) This is likely to be because few major corporations revise their investment plans before their interim accounts are finalized.
Given these circumstances, the Institute expects the growth (on the previous fiscal year) of fiscal 2006 investment plans estimated in the September Tankan to be +7.8%, slightly higher than that of fiscal 2005 plans in last year's September Tankan (+6.8%).

(3) Since the revision of the consumer price standards on August 25, the increasingly widespread view in the market has been that the likelihood of the Bank of Japan raising interest rates before the end of the year has declined, but, if the growth of capital investment plans matches the Institute's predictions, it is possible that expectations of an interest rate hike and anticipation of high prices will flare up again before the end of the year.

* Copies of this document are available from the Economic and Industrial Press Club.

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

Tel: 03-3288-4524

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