Published: Sunday, 15 Nov 2009 | 10:00 PM ET

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Japan's economy grew at the fastest pace in more than two years in the third quarter, as stimulus lifted consumer spending and capital spending bottomed out, but analysts say growth will slow as falling wages reduce the lure of subsidies on cars and electronics.

AP

Most economists say there is little chance of Japan's economy, which extended its rebound to a second quarter, returning to recession as stimulus spending overseas should be enough to support a gradual rise in demand for Japanese exports.

The outlook for domestic demand is less encouraging because even though the subsidies and tax breaks enacted by Japan's previous government will remain in place until next year, an expected decline in in year-end bonuses means households will have less to spend. This also means corporate spending will struggle to accelerate.

Japan's economy grew 1.2 percent in July-September from the previous quarter, faster than the median estimate for 0.7 percent growth. It was the largest gain in gross domestic product (GDP) since a 1.4 percent rise in January-March 2007 and compares with a revised 0.7 percent  expansion in April-June, which was the first growth in five quarters.

"With weakness ahead in private consumption or public spending, a slowdown is unavoidable in the January-March and April-June quarters," said Kyohei Morita, chief economist at Barclays Capital in Tokyo.

"The one bright spot is that capital spending turned positive. However, while this signals that capital spending is starting to rise from the bottom, the size is still not enough to promise the kind of speed that would be required to prevent a slowdown in the first half of 2010."

The new Democratic Party-led government's measures to support households will eventually help, but they may not make an impact until the second half of next year, economists say.

The Democrats are already mulling an extra budget to support growth, but Japan's large debt burden means options are limited. Should other signs of weakness in the economy emerge, that could open the Bank of Japan to government pressure to ensure monetary policy and corporate funding measures remain supportive of growth.

National Strategy Minister Naoto Kan said that the economy remained severe despite the pick-up in GDP and that he saw signs Japan was entering deflation.

He said the government wanted to work closely with the Bank of Japan to avoid deflation from deepening.

The yen held steady at about 89.60 per dollar but slipped about 10 ticks to 134.05 per euro after the GDP data. December 10-year JGB futures <2JGBv1> slipped 0.11 point to 138.77 in early trade.

The GDP figure translates into an annualised rise of 4.8 percent, bigger than a 2.9 percent expansion expected by economists. That follows 2.7 percent growth in April-June and a 12.2 percent contraction in January-March.

Private consumption rose 0.7 percent, better than a forecast for a 0.5 percent rise but slower than a 1.0 percent increase in the previous quarter.

Domestic demand contributed 0.8 percentage point to growth, the first positive contribution in six quarters.

Capital expenditure rose 1.6 percent, the first gain in six quarters and faster than a 0.1 percent increase forecast by economists.     

External demand contributed 0.4 percentage point, much slower than the 1.5 percentage point contribution in the previous quarter.

Economists polled by Reuters expect Japan's GDP to grow 0.3 percent in October-December and then slow to 0.1 percent growth in January-March 2010. hought.

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