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News Release

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

December 1, 2006

Business sentiment DI: largely unchanged in recent months; outlook cautious

With domestic and overseas economies beginning to slow, the Business Sentiment DI for December is expected to reflect a slowing of the pace of improvement in economic conditions.
In other words, given the mixture of positive factors, namely, the continued strength of domestic capital investment and the pause in the upward trend of the price of crude oil, and negative factors, namely, the lack of dynamism in consumer spending, the deceleration of overseas economies*1 and the instability of share prices, it is likely that there will be some variation in movement of the DI by industrial sector.
However, the scale of both the rise among large manufacturing companies, and the fall among large non-manufacturing companies is likely to be around 1 point, a relatively small change as compared with September. On an all industries/all sizes of company basis, the index is likely to remain unchanged at +6.

*1: Closer examination of recent trends in exports reveals that shipments of automobiles to the United States remain strong (the market share commanded by Japanese small cars has grown owing to a rise in non-price competitiveness), but that, owing to the deceleration of the US and Euro-zone economies and moves to curb investment in China, the growth of shipments of capital goods to the United States and Europe, shipments of production goods to Asia (excluding China) and shipments of automobiles to the EU shows signs of slowing.

Meanwhile, the "Forecast" DI for the period to March next year is highly likely to reflect a general mood of caution, for the following reasons:
(i) The uncertainty over the future trend of the US economy (the scale and duration of the slowdown) has yet to be resolved.
(ii) Owing to (i), there is a residual risk of a sharp rise in the value of the yen.
(iii) Wage growth is still slow and, given the expected impact of the
discontinuation of the fixed-rate income tax reduction, it is likely that consumer spending will remain sluggish (tending to increase the likelihood of production adjustments in the IT sector).

On an all industries/all sizes of company basis, the "Forecast" DI is likely to be a point lower than in December, at +5.

Thus, the December Tankan is highly likely to reveal the slow pace of improvement in business sentiment, but as the Japanese economy retains a considerable ability to absorb shocks, owing, among other factors, to the alleviation of various pressures for structural adjustment and the favorable balance of shipments to inventory in non-IT sectors (in contrast to the situation at the time of the collapse of the IT bubble or during the "plateau" phase of 2004), the impact of the negative factors on the DI is likely to be limited and the DI is likely to confirm that the upward trend in business confidence itself remains firm.

FY 2006 capital investment plans: possibility of 2-digit growth for first time since FY 1991

Capital investment in fiscal 2006 will be prone to short-term fluctuation owing to the timing of major projects in the materials an transportation sectors, but, basically, the gentle improvement in return on investment and plentiful money stocks at the macro-level mean that the pace of investment should remain high. In terms of content, investment is likely to be led by projects relating to the development of new businesses and to R&D, etc., the practical expression of a shift towards a more "aggressive" medium-to-long term management stance.

The growth of FY 2006 capital investment plans recorded by the December Tankan is likely to be somewhat higher than that of FY 2005 plans recorded by last year's December survey (+9.1%), at around 10.2% (includes land but excludes software). Given the pattern of adjustments recorded since FY 2003, in which the final figure has not been very different from that recorded in the December survey, if the Tankan reveals growth in line with the Institute's predictions, it is highly likely that the final effective growth rate will be between +9-10%.

If the content of the December Tankan turns out as predicted, the fact that the pace of recovery in business conditions has been slow in recent months is not likely to deal a "fatal blow" to the prospects of an interest rate hike before the end of the year.
However, as far as monetary policy over the next 1-2 years is concerned, the fact that the damage due to the deceleration of overseas economies has been slight (the resistance of the economy to shocks) and the fact that capital investment remains strong suggest that the conditions are growing ripe for steps to "normalize interest rates", once the immediate grounds for uncertainty have been reduced to some extent.

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

Tel: 03-3288-4263

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