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Forecast of GDP Statistics for the April-June Quarter of 2007

July 31, 2007

April-June quarter likely to have seen annualized growth of 0.6%

Statistics for the April-June quarter of 2007 (first preliminary QE due to be published on August 13) are likely to show that Japan's real GDP rose by 0.2% quarter-on-quarter (equivalent to an annualized rate of +0.6%). Although this will be positive growth for a tenth consecutive quarter, the statistics are likely to show that the pace of quarter-on-quarter growth has slowed as compared to the +1.3% recorded in October-December 2006 and +0.8% recorded in January-March 2007.

The two main reasons for this slowdown in quarterly growth are (i) the peaking of exports to the United States and (ii) the beginnings of deceleration in the growth of consumer spending, especially on travel and consumer electronics, against a backdrop of slow wage growth.

However, a number of facts suggest that the Japanese economy is not out of the ring yet. Among other things (i) the diversification of export destinations, through, among other things, the development of markets in resource-producing countries, is absorbing the impact of the peaking of exports to the United States (exports are maintaining an upward trend overall), (ii) the slowdown in capital investment has been a gentle one (the first preliminary reports suggest that quarter-on-quarter growth has been slightly greater than in January-March quarter) and (iii) as a result, real GDP as a whole has maintained growth on the same quarter in the previous year of over +2% (2.3%).

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

(1) Consumer spending (real: +0.0% on previous quarter, +0.1% annualized)

The statistics are likely to show that real consumer spending has remained at a similar level to that recorded in the January-March quarter. Depending on the results of the "Survey of Household Economy (June first preliminary report)" due to be released on August 3, the statistics may even record a slight fall.
Given the slow growth of wages, the relatively rapid growth of spending on travel and consumer electronics recorded in the January-March quarter is likely to have seen the beginnings of a slowdown. The statistics are also likely to show that the downward trend of demand for passenger automobiles has continued.
However, as spending remains strong in some areas, such as food services, overall consumer spending is likely to have risen by 0.8% on the same quarter last year, a growth rate slightly higher than the +0.7% average for fiscal 2006. This would suggest that it would be premature to claim that the general upward trend of consumer spending has begun to falter.

(2) Capital investment (real: +1.1% on previous quarter, +4.4% annualized)

According to the first preliminary report, the statistics are likely to show that the growth of capital investment on the previous quarter was slightly higher than that recorded in the January-March quarter (+0.3%). The indicators suggest that, in spite of a slowdown in the manufacturing sector, capital investment in non-manufacturing industries such as distribution and finance has remained firm, bolstering the overall figures.

(3) Net exports (real: –0.0% on previous quarter, annualized contribution –0.1%)

The statistics are likely to show that, quarter-on-quarter, net exports have made a negative contribution, albeit a very slight one, for the first time in four quarters (having made a quarter-on-quarter contribution of +0.4 points in the January-March quarter).
The breakdown is likely to show that quarter-on-quarter export growth has slowed relative to the +3.3% recorded in the January-March quarter (equivalent to an annualized rate of +13.8%) to +0.9% (or +3.7% annualized). The main reasons are the deceleration of exports to the United States (automobiles, construction machinery, etc.) and a slight fall in exports of electronic devices to China (including exports of components for game machines with a view to reverse imports to Japan), in reaction to the sharp rise recorded in the January-March quarter. However, shipments to the EU, where internal demand is strong, shipments to the Middle East, Russia and other "resource-producing countries" and shipments of non-IT related goods to China have continued to grow, and the growth of exports as a whole has continued.
Meanwhile, imports are likely to have grown slightly faster than in the January-March quarter, led by machinery for consumer use (real growth of +1.6%, equivalent to annualized growth of +6.4%). However, given that the growth of consumer spending has recently shown signs of slowing, it is possible that a proportion of imports have become distribution inventory (incidentally, commodity stocks held by major wholesalers at the end of June were up 14.3% on the levels recorded at the same time last year, up on the +7.2% increase recorded at the end of March. This has exerted an upward pressure on inventory investment.)

(4) GDP deflator (–0.0 points on previous quarter, –0.5 points on same quarter in previous year:)

The statistics are likely to show that the GDP deflator has remained virtually unchanged as compared with the previous quarter. Although construction-related demand (housing investment and public investment) has strengthened, the weakening of the consumption deflator and the fact that the upward trend of the import deflator has accelerated (contributing to a fall in the GDP deflator) have exerted downward pressure overall. As a result, nominal GDP for the April-June quarter is likely to have risen by 0.1% quarter-on-quarter (equivalent to an annualized rate of +0.5%: positive growth for 3 straight quarters, and growth of +1.7% on the same quarter in the previous year).

If this quarter's first preliminary QE are in line with the Institute's forecast, then although GDP growth will see a slightly greater deceleration as compared with the previous quarter, the mechanisms of economic recovery will continue to act. For this reason, we believe the impact of the first preliminary QE on the Bank of Japan's decision whether or not to raise interest rates in August will be neutral. If anything, (i) the problems surrounding sub-prime lenders in the United States and speculation as to the movements of the financial and capital markets due to the political situation in Japan and (ii) the question of whether the impact these will have on the future real economy will be limited or not, are likely to be more important issues in the decision whether or not to raise interest rates.

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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