Japan June Production Fall Adds to Recession Fears

Japanese industrial output fell a little more than expected in June and marked its second straight quarter of decline, adding to concern that the economy may be slipping into recession as high energy costs curtail corporate activity.

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The data reinforced the market view that the Bank of Japan will keep interest rates on hold at least for the rest of this year as uncertainty over economic prospects heightens.

"As industrial output fell (in April-June) for the second straight quarter, there will be a growing view that the economy has probably entered a recessionary phase," said BNP Paribas economist Yoshimasa Maruyama.

Economists say that since 1953, the economy has never escaped a recession when production fell for two quarters in a row.

Industrial output fell 2.0 percent in June after a 2.8 percent rise in May, below the median market forecast of a 1.7 percent decline, government data showed on Wednesday.

In the April-June quarter, production fell 0.7 percent from the previous quarter after declining by the same margin in January-March. The two-quarter decline was the longest since since 2001, when output fell in all four quarters.

Manufacturers were also cautious about the outlook for output. They expected output, the core component of production, to fall a further 0.2 percent in July and then decrease 0.6 percent in August, according to a survey taken by the government along with the output data.

That led the government to cut its assessment for industrial output for a second consecutive month to say it was "weakening."

Soaring energy and food costs have hurt corporate profits and dampened consumer sentiment, heightening fears that the economy's longest postwar expansion may be fizzling out, although many economists expect any recession to be mild.

Most economists polled by Reuters expect Japan's economy to contract slightly in April-June as a global credit crisis triggered by U.S. mortgage defaults hurts exports, and commodity costs deter consumption.

Preliminary gross domestic product data for the April-June quarter will be released on Aug. 13.

"The government may officially say the economy is in a recession," said Takumi Tsunoda, senior economist at Shinkin Central Bank Research. "But there will be only a mild recession given that the fall in output has been relatively limited and that companies no longer have triple excesses (in inventories, facilities and employment). I don't see a severe recession."

When Japanese officials talk about a recession, they do not necessarily use the word in the technical sense of two consecutive quarters of economic contraction. They often simply mean a downturn in the economic cycle.

The U.S. economic downturn has been clearly hurting Japan. Output of automobiles and semiconductor-manufacturing equipment fell in June as demand for them shrank mainly in the United States and Latin American countries, a government official told a briefing.

In another sign of weakness, inventories rose 1.2 percent in June to mark the second straight month of increases.

"Firm demand from overseas economies has been supporting production but as exports weakened in June, we can no longer count on it," said Takeshi Minami, chief economist at Norinchukin Research Institute.

Exports, a major driver of Japan's economy, fell in June for the first time in nearly five years, as shipments to the United States, Europe and Asian emerging markets sputtered.

Mounting signs of trouble for Japan's economy will likely keep the BOJ's focus tilted more toward downside economic risks than on the risk of runaway inflation, economists say.

"The Bank of Japan cannot ignore the fact that manufacturers forecast output declines in both July and August," said Kyohei Morita, chief economist at Barclays Capital Japan.

The BOJ has kept interest rates unchanged since February last year, when it raised them to 0.50 percent, and abandoned its tightening bias in April this year.