January-March quarter likely to have seen annualized growth of 3.2%

Statistics for the January-March quarter of 2007 (first preliminary QE due to be published on May 17) are likely to show that Japan's real GDP rose by 0.8% quarter-on-quarter (equivalent to an annualized rate of 3.2%), and that it has achieved an increase well above the latent growth rate, thought to be around +1.5%, for a second quarter following on from October-December 2006, as well growth for a ninth consecutive quarter.
The growth rate on the same quarter in the previous year is also likely to have moved into the 3-4% range (+3.0%) for the first time since the second quarter of 2004.

This anticipated "3% growth" will have been due largely to (i) the continued upturn in the recovery potential of consumer spending, led by the services sector, and (ii) the fact that the development of markets in newly developing and natural resource-producing countries has offset the slowdown in shipments to the United States, leading to double-digit annualized growth in exports of goods and services for the first time in 5 quarters.

There have been growing signs in recent months, especially among manufacturing companies and small and medium enterprises, that the economy may be "running on the spot", including (i) the fact that March saw the business sentiment diffusion index in the Bank of Japan Tankan (Short-Term Economic Survey) fall for the first time in 2 years and (ii) the fact that mining and manufacturing production fell in January-March for the first time in 6 quarters (by 1.4%), but the 1st preliminary QE are likely to show that the economy is "holding firm", underpinned by non-manufacturing industry and by larger companies.
Ultimately, it would be fair to say that the various domestic economic indicators collectively suggest that although the economy is somewhat heavy in its movements, the recovery trend itself has been maintained.

The movements of the major elements of demand and the GDP deflator are as follows:

(1) Consumer spending (real: +0.7% on previous quarter, +3.0% annualized)

The statistics are likely to show that, led by spending on food services and other service industries and digital consumer electronics, real consumer spending rose quarter-on-quarter, achieving growth almost as strong as that recorded in the October-December quarter of 2006. As indicated by the trend of growth on the same quarter in the previous year since the April-June quarter of 2006 (+1.5% → –0.3% → +0.5% → +1.3%), consumption has recovered from the sharp downturn that occurred during the second half of 2006, due to poor weather and stockmarket fluctuation, and may be considered to be returning, albeit slowly, to the average pace of recovery in consumption recorded during the present recovery phase.
Nevertheless, sluggish wage growth means that households remain highly conscious of spending priorities, and there is still considerable variation in sales performance between business sectors and product categories.

(2) Capital investment (real: +1.1% on previous quarter, +4.3% annualized)

Although it has slowed since the double-digit annualized growth recorded in the October-December quarter (+13.2%), the statistics are likely to show that capital investment continues to rise on the strength of continued improvement of capital investment efficiency and plentiful money stocks. The half-quarterly statistics in the March Tankan suggest that large corporations and the materials industries are leading the way in investment.

(3) Inventory investment (real contribution to growth on previous quarter: –0.2 points, annualized contribution –0.7 points)

The statistics are likely to show a fall in inventory investment, for a second quarter, in some areas of the manufacturing sector (especially transportation machinery and IT-related goods), chiefly due to the reduction of inventories of finished products.

(4) Net exports (real: +0.4% on previous quarter, annualized contribution +1.6%)

The statistics are likely to show that, owing largely to the acceleration of export growth, net exports have improved on the 0.1-point growth recorded in October-December 2006 (equivalent to annualized growth of 0.4 points).
Exports have achieved double-digit growth for the first time in 5 quarters (real growth of +3.3% on the previous quarter, equivalent to annualized growth of +14.0%). The slowdown in shipments to the United States, especially in the areas of construction machinery and automobiles, has been offset by the strong performance of shipments to the EU, where domestic demand is firm, shipments to the Middle East, Russia and other resource-producing countries (centering on automobiles), and shipments to China, centering on IT-related goods (including exports of components for game machines with a view to reverse imports to Japan). Moreover, the rise in the value of shipping business handled by Japanese companies in conjunction with the growth of trade with newly developing countries (increased demand from newly industrialized countries for shipping to third countries other than Japan leading to business growth for Japanese shipping companies, which have superior packing technology and shipping capability) has contributed to the overall acceleration of export growth.
Imports are thought to have risen quarter-on-quarter for the first time in 3 quarters (real quarter-on-quarter growth of +1.0%, equivalent to annualized growth of +4.0%). This is due to growth in imports of airplanes and spending on services such as shipping and travel. However, against a background of production speed adjustments in the manufacturing sector, imports of raw materials and intermediate goods are slowing, and the overall rise in imports is likely to be far smaller than that in exports.

(5) GDP deflator (–0.1 points on previous quarter, –0.6 points on same quarter in previous year:)

The statistics are likely to show that the GDP deflator has fallen quarter-on-quarter for a ninth consecutive quarter. Although construction-related demand (housing investment and public investment) has strengthened, the weakening of the consumption deflator and the fact that the import deflator has risen for the first time in 2 quarters (+1.0%, contributing to a fall in the GDP deflator) have exerted downward pressure overall. As a result, nominal GDP for the January-March quarter is likely to have risen by 0.7% quarter-on-quarter (equivalent to an annualized rate of +2.9%: positive growth for 2 straight quarters, and growth of +2.4% on the same quarter in the previous year).

Looking ahead to the April-June quarter, the economy is likely to continue recovering, on the strength of growth in employment and capital investment.
However, the basic problems of variation in performance between industries in the corporate sector, and sluggish wage growth hampering the recovery in consumer spending are unlikely to be resolved in the near future.
Owing in part to the reaction to the relatively rapid growth of consumer spending expected for the January-March quarter and to the slowing of the US economy, the growth rate is likely to slow in the April-June quarter. (The Institute will revise its growth forecast following the publication of the 1st preliminary QE.)

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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