July-September quarter likely to have seen annualized growth of 2.7%

Statistics for the July-September quarter of 2006 (first preliminary QE due to be published on November 14) are likely to show that Japan's GDP increased for a seventh consecutive quarter, rising by 0.7% on the previous quarter (equivalent to an annualized rate of +2.7%).

The principal reason for the growth surge is a sharp increase in net exports (exports – imports). Not only has the pace of export growth recovered since the slowdown during the April-June quarter, but imports have also fallen for the first time in three quarters, owing to a downturn in certain items.
Against this backdrop, the contribution to growth of domestic private-sector demand has seen a slight fall. Since the period of fairly rapid growth recorded in fiscal 2005, domestic private-sector demand has been settling towards a more sustainable pace. Public-sector demand has also continued to decline.

In the 1st preliminary QE for July-September, the consumer spending deflator is to be revised going back to the January-March quarter of 2005, to reflect the recent review of CPI criteria. This is expected to result in upward revisions of the real growth rate for fiscal 2005, by 0.2 points (consumer spending 0.4 points), and of year-on-year change in real GDP for the April-June quarter of 2006, by 0.3 points (consumer spending 0.5 points).
Consequently, following the publication of the QE, it is likely that current estimates of the Japan's real growth rate and latent growth rate will have to be revised to some extent.

Movements of the major elements of demand and the GDP deflator

(1) Consumer spending (real: +0.2% on previous quarter, +0.9% annualized)

The statistics are likely to show that the growth of consumer spending has slowed since the April-June quarter.This may be attributed to the poor weather and to consumers taking an increasingly cautious approach to spending as a result of the softening of share prices this summer.
However, the basic scenario in which the steady spending on services, including telecommunications (mobile phones, the Internet, cable TV) and buoyant demand for some consumer electronics (washing machines, flat-screen TV sets, etc.) underpins the overall level of spending remains unchanged. September brought signs of improvement in both the weather and share prices, and department store sales, etc. began to recover. It is therefore probable that the growth of consumer spending itself has continued.

(2) Housing investment (real: +1.6% on previous quarter, +6.6% annualized)

The statistics are likely to show an emerging reaction to the downturn in the construction of apartments for sale recorded in the April-June quarter.

(3) Capital investment (real: +0.5% on previous quarter, +2.1% annualized)

The statistics are likely to show a sharp slowing of growth in capital investment since the April-June quarter. However, a large part of this slowdown can be attributed to a short-term "speed adjustment" to bring growth back down, from the "somewhat overheated" pace (annualized rates of +13.7% and +15.4%) that had continued since the January-March quarter, partly as a result of a concentration of major projects, to a more moderate pace.
Capital investment is likely to have maintained strong growth on a par with the average for fiscal 2005 (+7.5%), at +7.7% on the same quarter of the previous year, owing chiefly to positive investment on the part of manufacturing and transportation sectors with a view to meeting global demand for digital consumer electronics and automobiles and to investment in development and training with a view to the creation of products and services with higher added value.

(4) Net Exports (real contribution to growth on previous quarter: +0.5 points, annualized contribution: +2.1 points)

The statistics are likely to show that the pace of export growth, which had slowed in the lead during the April-June quarter, has recovered (to +2.8% year-on-year, equivalent to an annualized rate of 11.6%). Slower exports of production goods to Asia, owing to the deceleration of the US economy among other factors, is likely to have been offset by an acceleration in the growth of shipments to countries that export natural resources. Although shipments of capital goods and production goods to the United States show signs of having peaked, demand for automobiles has remained strong and, if anything, overall export growth is likely to have exceeded that of the April-June quarter.
Meanwhile, the statistics are likely to show that imports have fallen for the first time in three quarters (by –1.0% on the same period in the previous year, equivalent to an annualized rate of –4.0%), centering on food and raw materials, imports of which tend to fluctuate to a significant degree.

(5) GDP deflator (change on same quarter in previous year: –0.7 points)

The revision of the CPI criteria means that, from the coming QE onwards, the value of the GDP deflator for 2005 onwards is likely to be revised downwards by 0.2-0.3 points, owing largely to the consumer spending deflator. However, the basic pattern of shrinking value, which has persisted since the deflator reached its lowest level in the October-December quarter of 2005, remains unchanged. The statistics are likely to show a 0.4-point reduction in the July-September quarter as compared with the April-June quarter.
A breakdown of the figures will reveal that although the double-digit growth of the import deflator has continued (+11.6% year-on-year, exerting downward pressure on the GDP deflator), the domestic demand deflator has turned positive for the first time since the October-December quarter of 2004 (at +0.2% year-on-year).

Although the pace of growth for the July-September quarter is likely to be somewhat higher than that recorded for the April-June quarter, it is likely that the second half of fiscal 2006 will see the growth of both domestic and overseas demand slowing as the deceleration of the US economy begins in earnest and wages continue to recover at a slow pace.
However, the three points below suggest that the economic recovery trend itself is unlikely to collapse, and, if the US economy succeeds in making a soft landing, economic growth can even be expected to accelerate once more in fiscal 2007:

(i) Enterprises are likely to maintain a positive stance on capital investment and employment for a little while longer (the slowdown in capital investment in the July-September quarter can also be regarded as a positive development in terms of the sustainability of the economic recovery).
(ii) If domestic share prices remain at or near their present level (the Nikkei Average remains between ¥16,000 and ¥17,000), consumer spending in fiscal 2006 can be expected to have an asset effect on a par with that recorded in fiscal 2005.
(iii) Although the pressure for inventory adjustments in the IT sector may strengthen in the new year, the balance of inventory and shipments is improving in non-IT sectors such as materials, and there is little risk that the pressure will rise to the point of bringing about a major adjustment across the manufacturing sector as a whole.

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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