Japan's Economy Contracts, Adds to Recession Fears

Japan's economy contracted 0.6 percent in the second quarter, reinforcing views that the world's No.2 economy has slipped into recession after its longest postwar expansion.

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Crumbling exports, weak consumption and declines in public and private investment spending led to the first contraction in four quarters as high energy and raw material costs bite and the impact of a U.S. slowdown spread to emerging nations.

"The results are very poor but we've been expecting this to happen," said Takeshi Minami, chief economist at Norinchukin Research Institute. "My biggest worry is falling private consumption. Rising prices have been clearly affecting consumption. GDP will remain in a downward trend as long as consumption stays weak."

The contraction shown by government data released on Wednesday matched economists' consensus forecast.

The yen and Japanese government bond markets showed limited initial reaction. The Nikkei 225 Average opened down 0.74 percent at 13,205.64.

With the economy losing its driving force, many economists and government officials say Japan is either falling into a recession or is already in one, ending a growth cycle that began in early 2002, the longest of the postwar period.

Japan measures a recession as a downturn in the economic cycle, which varies from the more widely used definition of two straight quarters of economic contraction.

The contraction was an annualized 2.4 percent, compared with 1.9 percent annual growth in the same quarter in the United States, where an emergency dose of government stimulus supported the economy.

But many economists say the Japanese economy is in much better shape than when it went through slumps in 2001 or 1998, with companies having cleaned up their balance sheets after the collapse of an asset bubble in the 1990s.

Caught between gloom and rises in food and daily goods in an economy where deflation was common for most of the past decade, the Bank of Japan has been expected to keep the key policy rate at an already low 0.5 percent for a while, and the GDP figures did not change that view.

"We can't expect export growth to accelerate any time soon, so the economy will remain in an adjustment phase for the rest of this year," said Takumi Tsunoda, a senior economist at Shinkin Central Bank Research.

"But we can probably avoid a full-fledged recession, as in several straight quarters of GDP contraction. We still expect the Bank of Japan's next policy move to be a rate hike, but it won't come for the rest of this year."

The second-quarter contraction followed quarterly growth of a revised 0.8 percent, or an annualized 3.2 percent rise, in January-March, when the economy managed to weather the U.S. economic slowdown and consumption was boosted partly due to an extra day for the leap year.

Private consumption, which accounts for some 55 percent of GDP, fell 0.5 percent from the previous quarter, after recent rises in food and gasoline prices hurt consumer sentiment and weak wages prompted tighter purse strings.

Another culprit in the downturn is weakening exports. Shipments to the United States have already faltered, but now those to emerging Asia have begun to sputter after maintaining growth through the first year of the global credit crisis.

Corporate capital spending fell 0.2 percent in the second quarter, following a revised 0.1 percent drop in January-March and marking the second straight quarter of decline.

Public investment dipped 5.2 percent, the first drop in three quarters, while private housing investment fell 3.4 percent in contrast to a median market forecast for a 1.5 percent rise.