By Yasuhiko Seki

TOKYO (MNI) – The Japanese economy suffered its first contraction
in just over a year in the last quarter of 2010 as the government
unwinds crisis measures, but the world’s third-largest economy is
expected to avoid a recession as overseas economies are now on the mend.

Gross domestic product shrank by a real 0.3% on quarter in
October-December after a revised 0.8% rise in July-September, hit by
what appears to be a temporary dip in spending and slumping exports,
Cabinet Office data released on Monday showed.

GDP dropped at an annualized pace of 1.1% in Q4, compared with a
revised 3.3% rise in Q3 (revised down from the initial reading of +1.1%
q/q, or +4.5% annualized).

But the Q4 drop was smaller than the median forecast by economists
for a 0.5% quarter-on-quarter fall, or an annualized rate of 1.9%, with
economist forecasts ranging from 0.2% to 0.8% fall, or at an annualized
pace of 0.8% to 3.1%.

Japanese financial markets showed little reaction to the GDP data,
with the Nikkei 225 Stock Average rising 0.8% this morning and the yield
on 10-year JGBs falling half a basis point to 1.300%. The yen moved in a
range of Y83.15 to Y83.57 versus the dollar.

“The GDP data confirmed that the Japanese economy was indeed in a
soft-patch in the last quarter of 2010, hit by swings in demand for
autos following the end to the government’s subsidies and a temporary
downturn in overseas demand,” said Taro Saito, senior economist at NLI
Research Institute, a unit of Japan’s largest life insurer Nippon Life
Insurance Co.

New vehicle sales in Japan logged the fifth consecutive
year-on-year fall in January, after the government ended its subsidy for
buying low emission automobiles in September, according to the latest
data released by the Japan Automobile Dealers Association.

With the unwinding of government stimulus measures taken after the
collapse of Lehman Brothers Holdings in 2008 continuing to take a toll
on the industry, Toyota Motor Corp cut domestic output of Toyota-and
Lexus-brand cars in December 2010, the fourth straight month of reduced
production.

“But there are emerging signs that domestic demand for autos will
soon bottom out and exports will regain traction,” NLI’s Saito said.

“As a result, consumer spending is most likely to rebound in the
current quarter to March, underscoring that the Japanese economy is
moving out of a lull,” he added.

Private consumption, which makes up about 55% of GDP, fell 0.7% q/q
in Q4 after rising 0.9% in Q3, making a negative 0.4% percentage point
contribution to GDP (vs. +0.5 point in Q3).

Durable goods spending actually rose 3.1% on quarter in Q4, as
consumers rushed to electronic retail stores before Dec. 1, when the
government tightened its rules for providing reward points for purchases
of TVs, refrigerators and air-conditioners/heaters that operate on less
power.

Kaoru Yosano, the minister for economic and fiscal policy, showed
his confidence in a quick turnaround and the Bank of Japan is now
believed to tone up its assessment of the economy when policymakers
gather for a two-day board meeting that ends on Tuesday.

BOJ Governor Masaaki Shirakawa said last week that “recent data
suggest that Japan’s economy looks like it is about to emerge from that
pause,” offering a more positive outlook on the state of the economy
than before.

Private-sector economists agree with Shirakawa’s view.

“Japan can avoid a recession in the January-March quarter, as
exports are now moving out of a temporary lull on the back of brisk
recovery in emerging markets and a rebound in demand among developed
countries,” said Takeshi Minami, chief economist at Norinchukin Research
Institute.

Japanese exports rose 12.9% in December from a year earlier to
Y6.11 trillion, faster than a 9.1% rise in November, as shipments to
China hit a record high of Y1.285 trillion in the final month of 2010.

As Japan Inc. braces for a widely expected rebound from what
appears to be a temporary dip in the fourth quarter, production at the
nation’s factories and mines rose a seasonally adjusted 3.1% in December
from the previous month, bringing the industrial output index up to
94.6, the highest since 94.8 marked in July 2010.

Core machinery orders, which are viewed as a leading indicator of
corporate capital Investment, are forecast to rise 2.7% in the first
quarter of 2011 from the previous three months, according to the recent
survey of companies conducted by the Cabinet Office.

In the fourth quarter of 2010, exports fell 0.7% on quarter,
posting the first quarterly drop in seven quarters after +1.5% in the
previous quarter, while imports fell 0.1% q/q, marking the first
quarterly drop in six quarters (+2.9% in Q3).

Among other major drivers, business investment in equipment and
software rose 0.9% in Q4, decelerating from +1.5% in Q3. Capex made a
positive contribution by 0.1 percentage point to Q4 GDP (vs. +0.2 point
in Q3).

Private-sector inventory changes added a 0.2 percentage point to
GDP in Q4 after pushing up overall growth by 0.3 percentage point in the
third quarter.

Housing investment rose 3.0% in the fourth quarter, after rising
1.8% q/q in Q3. This category made a positive 0.1 percentage point
contribution.

Meantime, analysts warned of underlying downside risks stemming
from rising prices of food and energy.

Coffee beans producers ranging from Ajinomoto General Foods and Key
Coffee recently decided to hike deliver prices of their coffee beans
while Starbucks Japan also decided to boost prices of some of its
coffees.

“While rising prices of commodity products have so far had only a
negligible impact on the nation’s economy, this would yield a more
outright impact, should crude oil prices climb above $100 a barrel
again,” said Kazuto Uchida, chief economist at Bank of Tokyo Mitsubishi
UFJ.

Gross domestic income, which includes trading gains or losses
stemming from changes in the terms of trade, fell 0.2% in the fourth
quarter from the previous three months following a 0.8% gain in the
July-September quarter.

The GDP deflator, which measures the degree of deflation, fell by
an unadjusted 1.6% in the fourth quarter from a year earlier, while the
import deflator rose 1.7%.

“But price rises caused by rising commodity prices are highly
unlikely to encourage the Bank of Japan to start unwinding the monetary
easing,” Uchida said.

“If we look solely at domestic factors, the BOJ may need to wait
until around late 2013 before it can resume the normalization process of
its monetary policy,” he said.

tokyo@marketnews.com
** Market News International Tokyo Newsroom: 81-3-5403-4835 **

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