— Faulty Seasonal Adjustment May Partly Explain Unexpected Decline

By Max Sato

TOKYO (MNI) – The unexpected decline in Japanese industrial
production in June is a temporary blip, due in part to distorted
seasonal adjustments caused by the Lehman shock, and does not contradict
expectations that the economy will remain on a recovery track.

Both government officials and private-sector economists expect
production of cars, electronics and other goods to stay on an uptrend on
a quarterly basis after a temporary dip in June and July.

The economy is forecast to show the fifth straight quarter of GDP
in April-June, judging from gains in capital goods shipments reported in
industrial output data.

Preliminary Q2 GDP, due out Aug. 16, will also be backed by the
recovery in exports and business investment in equipment. Consumer
spending may not add much to the expected modest growth in GDP but
sentiment is improving amid easing job and wage cuts.

Industrial production unexpected fell 1.5% in June, the first
month-on-month drop in four months, as passenger cars, semiconductors
and chemicals led the decline, data from the Ministry of Economy, Trade
and Industry released Friday showed.

The seasonally adjusted monthly drop in June was much weaker than
the consensus forecast for a flat reading on the month. Moreover, the
drop was in contrast to the 0.4% m/m gain predicted for June by the
ministry’s forecast survey last month.

But the METI repeated its assessment adopted in June 2009 that:
“Industrial Production continues to show an upward movement” while
adding that “it has been pausing temporarily in part.”

“We are maintaining our view on the trend as we didn’t hear any
negative comments from firms for June and our survey shows that output
is forecast to rebound by 2.0% in August after a slight 0.2% drop, which
will be caused by trouble at some factories,” a METI official said.

Akiyoshi Takumori, chief economist at Sumitomo Mitsui Asset
Management, believes that the sharp drop in June was a blip, caused
partly by walkouts at Chinese factories and a temporary drop in demand
for mobile phone parts from South Korea.

“Month-on-month production figures have also been distorted by the
way seasonal adjustments are being made. Under the current formula,
figures in the winter and spring tend to have an upward bias while those
in the summer will appear more depressed than what output really is,” he
said.

Unlike seasonal adjustments to quarterly GDP that are made to
recent past quarters every time the data is released (for both
preliminary and revised series), industrial production figures are
adjusted for seasonal factors only once a year, in April, for the past
12 months.

“The 7.0% quarter-on-quarter surge in industrial output in
January-March this year is obviously overestimated while the 1.4% rise
for April-June will probably be upwardly revised to around 3% when the
annual revision is applied next year,” said Takumori.

Because of the unusually steep contractions in Q4 of 2008 and Q1 of
2009 following the collapse of the U.S. investment bank Lehman Brothers
in September 2008, the economic performances in subsequent second and
third quarters have been underestimated and the fourth and first
quarters have been overestimated.

Today’s production data also showed that capital goods shipments —
which reflect the strength of corporate capital spending in GDP — rose
4.9% in April-June, posting the fourth straight quarter-on-quarter rise
after soaring 17.2% in January-March.

Shipments of capital goods excluding transport equipment also rose
for the fourth quarter in a row, up 7.4% in Q2 after rising 14.3% in Q1.

To forecast private consumption from the supply side, the latest
output data showed that durable consumer goods shipments fell 1.7% q/q
in April-June after a 9.1% rise in January-March, indicating that there
was a pullback in demand for consumer electronics after rush purchases
in March before the government tightened rules on reward programs for
buying energy-efficient flat-screen TVs.

Meanwhile, non-durable goods shipments rose 2.9% in Q2, reversing
from a 2.9% drop in Q1.

Judging from these figures and continued robust Japanese exports to
China, Takumori expects the Q2 GDP to show an annualized growth rate of
about 1.8% (+0.4% q/q), slowing from the 5.0% rise in Q1 (+1.2% q/q),
which was exceptionally high for Japan’s current economic health.

Naoki Iizuka, senior economist at Mizuho Securities, also forecasts
that “the Q2 GDP figures will look a lot different than what the
headline industrial output figure suggested” partly because of strong
capital goods shipments.

He expects a clear expansion in capex and housing investment and
flat consumption in Q2. He also forecast high exports, although rising
imports will probably reduce the net external demand.

Today’s data also showed that average real household spending rose
a modest 0.5% from a year earlier to Y276,494 in June, as higher
spending on home repairs, overseas holiday tours and electronics offset
lower medical, rail transport and mobile carrier costs. It was the first
year-on-year rise in three months in inflation adjusted terms.

“Looking ahead, the July-September outlook for machinery orders to
be included in the June data due out on Aug. 11 will give us a good clue
to what the second half of 2010 growth will be like and could change
investors’ mindset,” said Iizuka.

Core machinery orders are estimated to have risen by 1.6% q/q in
April-June after +2.9% in January-March.

“If the July-September outlook shows a flat or negative figure, it
could stir fears about the sustainability of capital spending,” Iizuka
said. “But if it shows a sharp increase, it would correct the excessive
pessimism held among some market participants.”

Core private-sector machinery orders, which exclude volatile demand
from electric utilities and for ships, are viewed as a leading indicator
of corporate capital spending.

Friday’s data releases also pointed to brighter signs in the labor
market.

Japan’s unemployment rate rose to 5.3% in June from 5.2% in May, as
the number of the unemployed rose from the previous month, data from the
Ministry of Internal Affairs and Communications showed .

But the number of unemployed people fell when compared with a year
earlier, the first drop in 20 months, indicating that the labor market
is slowly catching up with the recovery in production and exports.

On an unadjusted basis, the number of employed people posted the
29th straight year-on-year drop in June, down by 200,000 (-0.3%) y/y to
62.80 million. But the pace of decline decelerated from the drop of
470,000 (-0.7%) in May, reflecting easing severity of labor conditions.

The number of those who lost their jobs and were looking for work
fell 200,000 y/y to 1.01 million in June after falling 70,000 in May,
also a sign of improving labor conditions.

Meanwhile, the number of people who quit their job voluntarily to
look for other openings and those who returned to job hunting rose
sharply by 80,000 y/y to 1.05 million in June after rising 10,000 in
May, indicating people are more confident about job offer prospects.

Separately, the Ministry of Health, Labor and Welfare said that the
ratio of job offers to job seekers at government placement offices stood
at a seasonally adjusted 0.52 in June, up from 0.50 in May. That means
there were only 52 job offers for every 100 people looking for work but
it was better than the month before.

msato@marketnews.com
** Market News International Tokyo Newsroom: 81-3-5403-4833 **

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