Deflation Stalks Japan, Stocks Up on Recovery Hopes

Japan slipped to the brink of deflation but early and tentative signs of economic recovery elsewhere encouraged investors to take on more risk, further boosting stocks on Friday.

Wary of a return of the type of risk-taking that nearly wrecked the financial industry and set off a global recession, officials on Thursday proposed strict new rules to supervise hedge funds and other powerful financial institutions outside banking.

U.S. Treasury Secretary Tim Geithner called for a powerful systemic risk regulator, saying "comprehensive reform" was needed, "not modest repairs at the margin" to help recover from the worst credit crisis since the 1930s.

The global recession, combined with a slide in oil prices, pushed Japanese consumer price inflation to zero in February. Retail sales also fell further than expected, more evidence that slumping global appetite for Japanese exports is hurting demand in the world's second-largest economy.

"Japan is facing consumer price deflation," said Akira Maekawa, a senior economist at UBS Securities. "Japanese companies are still producing more than consumers want to buy."

Policymakers have been struggling to stimulate growth, cutting interest rates to close to zero in many big economies, increasing infrastructure spending and buying assets from troubled banks and companies to pump more money into the system.

Japanese lawmakers are likely to approve on Friday the government's 88.5 trillion yen ($896 billion) budget for the fiscal year starting April 1, the country's largest ever.

This budget and extra stimulus plans for the current fiscal year will bring Japan's government stimulus spending to 12 trillion yen since the financial crisis pushed the world's largest economies into recession.

Stocks Gain On Recovery Hopes

The U.S. economy, the world's biggest, shrank at its fastest pace since 1982 in the fourth quarter, data on Thursday showed. But the headline figure of a 6.3 percent contraction was slightly better than the consensus forecast of a 6.5 percent decline in a Reuters survey of economists.

In spite of this, Atlanta Federal Reserve President Dennis Lockhart warned that one month of improved data does not constitute an economic recovery and the recession in the United States will last for at least a few more months.

He was referring to data on Wednesday that showed new orders for long-lasting U.S.-made goods rose in February for the first time in seven months and new home sales rebounded.

The data helped stocks recover on Wall Street, with the positive tone spilling into Asia trade as investors bet the recent rally marked a turning point.

The tech-heavy Nasdaq ended 3.8 percent higher to turn positive for 2009 and the Dow Jones industrials added 2.2 percent, taking its gains over the past 13 sessions to 21 percent.

Japan's Nikkei 225 Average rose 1 percent, boosted by property companies on hopes for more government support for the sector, while stocks elsewhere in the
Asia-Pacific region added 0.1 percent.

Higher oil prices and better-than-expected results from U.S. consumer electronics retailer Best Buy , consumer foods business ConAgra and soft drinks company Dr Pepper Snapple also lent support.

"We've hit the bottom, we're making our way up," said Bell Potter Securities private client adviser Stuart Smith in Australia.

New Zealand Dilemma

But the increased appetite for risk was creating headaches for New Zealand's central bank, which is grappling with ways to stimulate a weak economy while still attracting enough foreign investment to finance its heavy foreign debt burden.

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The small economy suffered its sharpest contraction in 16 years in the fourth quarter, increasing pressure on the Reserve Bank to cut already record low interest rates.

Combined with a surge of as much as 18 percent in the New Zealand dollar , which is punishing exporters, much of the central bank's efforts are
being undone.

Signs were somewhat brighter in South Korea, until recently a source of concern for investors worried about its hefty foreign debt burden.  Asia's fourth-largest economy shrank by a seasonally adjusted 5.1 percent in October-December 2008 from the previous three months, slower than a 5.6 percent drop first estimated in January, the Bank of Korea's revised figures showed.

Analysts said South Korea's economy would probably reach bottom by the second quarter of this year before taking off for a modest recovery thanks to a series of stimulus packages and monetary easing by authorities at home and around the world.

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