Monthly Economic Report (July 2004)

Assessment of the current state of the Japanese economy

  The economy is recovering at a solid pace as improvements in the corporate sector are extending into the household sector.
  As for short-term prospects, the economic recovery is expected to continue as the world economy recovers and the domestic private demand increases steadily. On the other hand, attention should be given to the effects on the economies of global interest rate developments and other factors.

Policy stance

  Acceleration and expansion of structural reforms will be pursued through early implementation of "Basic Policies for Economic and Fiscal Management and Structural Reform 2004."

  The Government, with the Bank of Japan, will continue to take powerful and comprehensive actions to secure stability of money and capital markets, and will further strengthen its policy efforts to ensure a breakaway from deflation after the intensive adjustment period.

Detailed explanations

1.Demand trends such as consumption and investment

Private consumption is moderately increasing.
  Private consumption is moderately increasing. Behind this are the facts that income is moving steadily and that consumer confidence has continued to improve. The Synthetic Consumption Index, which synthesizes demand-side statistics (Family Income and Expenditure Survey) and supply-side statistics (Indices of Industrial Producer's Shipment, etc.), has remained on a moderate increasing trend, although it decreased slightly in May partly in reaction to sharp increase in April from the previous month.
  Among individual economic indicators for May, the Family Income and Expenditure Survey shows that real consumption expenditure has continued to increase, mainly due to increase of net income, on a year-to-year basis for seven consecutive months, although it declined from the previous month partly in reaction to sharp increase in April. Out of sales indicators, retail sales decreased from the previous month due mainly to sluggish sales at department stores and supermarkets, caused in part by bad weather weekends, although machinery & equipment retail (home appliances, etc.) increased. Home appliance sales increased from a year earlier, as sales of DVD players and thin-shaped TVs continued to be brisk. New car sales decreased in June from the previous month after posting a month-to-month increase in May. Overseas travel increased from a year earlier, although domestic travel decreased from a year earlier. Eating out posted a year-on-year rise in May partly due to the fact that national holidays didn't fall on Saturday and Sunday.
  As for short-term prospects, private consumption is expected to increase steadily if the income environment of households improves, as the employment situation is improving.

Business investment is increasing.
  Business investment is increasing thanks to an improvement of corporate profits and progress in capital stock adjustment. The Quarterly Financial Statements Statistics of Corporations by Industry, which is a demand-side indicator of business investment, shows that business investment has increased for four consecutive quarters in manufacturers and it has increased for two consecutive quarters in non-manufacturers. Shipment of capital goods, which is a supply-side indicator of machinery equipment investment, is also on an increasing trend. Software investment is moderately increasing. The Synthetic Business Investment Index, which synthesizes the demand-side statistics and the supply-side statistics, has been generally picking up, although it declined in May from the previous month.
  According to the Bank of Japan short-term business sentiment survey (tankan), business investment in fiscal 2004 is expected to increase for two years on end and its increase of large manufacturers has been at the highest rate since 1988 for the survey in June. And corporations' sense of excess capacity, which indicates future business investment, has continued its improvement. As for leading indicators, machinery orders have been recently increasing, although it weakened in the January - March quarter. Construction work planned have been temporarily weakening due to a decrease of large construction plans. Business investment is expected to remain on an increasing trend, as corporate profits are expected to continue their improvement.

Housing constructionhas remained roughly flat.
  Housing construction has remained roughly flat. This is because construction of owned houses and houses for sale moved steadily, although construction of houses for rent, which had been increasing recently, declined slightly. In May, housing construction increased 4.7% from the previous month to an annual rate of 1.169 million units. Total floor space generally followed the same movement. Housing starts are expected to move steadily if income environments of households recover along with the improvement in the employment situation.

Public investment has been generally sluggish.
  Reflecting the budget situations of the state and local governments, public investment has been generally sluggish.
  In the national supplementary budget for fiscal 2003, public investment-related expenses decreased sharply from the previous fiscal year, as the Government appropriated only about 0.2 trillion yen for disaster countermeasures. Out of local public investment expenses under the fiscal plans of local governments for fiscal 2003, those for projects undertaken by local governments on their own funding have been slashed by 5.5% from the previous year.
  Reflecting this situation, public works orders, the public works contract value, and orders received by 50 major companies in the January - March quarter of 2004 decreased from a year earlier, as they did in the previous quarter.
  Public investment in the April-June quarter of 2004 is likely to continue posting a year-on-year decrease in view of the decreases in the contracted amount of public works, etc. in April and May, and the budgetary conditions of the state and local governments.
  In the national budget for FY2004, the Government slashed public investment-related expenses by 3.3% from the previous fiscal year and prioritized budget allocations to areas that will lead to the expansion of employment and private demand, and by scrutinizing the purpose and achievements of each project. Out of local public investment expenses under the fiscal plans of local governments, those for projects undertaken by local governments on their own funding have been slashed by 9.5% from the previous year subjected to systematic curbs over a medium term and priority-based allocations will be implemented.

Exports have increased. Imports are moving sideways. The surplus in the trade and services balance has been flat.
  Exports have increased. By region, exports to Asia, mainly of electrical machinery & equipment, have increased. Exports to the U.S. have remained flat, although transportation equipment increased. Exports to the EU, mainly of transportation equipment, have generally increased. As for the outlook for exports, close monitoring is required for the movement of exchange rates, although exports are expected to increase in line with the steady recovery in the world economy.
  Imports, which increased especially in machinery equipment, remained flat, as imports of mineral fuels have been weakening. By region, imports from Asia, which increased mainly in machinery equipment, have remained on a moderate increasing trend. Imports from the U.S., mainly of machinery equipment, decreased. Imports from the EU have been flat.
  Looking at the international balance of payments, the surplus in the goods and services account has become flat, as the deficit in the services account increased due to a rise in the number of Japanese tourists abroad, although exports in volume have increased and imports have become flat.

2. Corporate activities and employment

Industrial production is increasing.
  Industrial production is increasing. Mainly in information-related producer goods and capital goods, industrial production is increasing in broad goods, reflecting increases in exports and business investment. Although inventory remains at a low level, corporations are cautious about inventory building.
  As for the prospects of industrial production, the recovery is expected to continue on the strength of the steady recovery in the world economy. Judging from the inventory cycle, industrial production is not in the adjustment phase. The Survey of Production Forecasts indicates industrial production is expected to decrease in June and increase in July.
  Tertiary industry activities are increasing moderately.

Corporate profits have increased markedly. Firms' judgment on current business conditions shows further improvement. The number of bankrupt companiesis decreasing.
  According to the Quarterly Financial Statements Statistics of Corporations by Industry, corporate profits have posted a year-to-year increase for seven consecutive quarters since the July-September quarter of 2002. In the first quarter of 2004, corporate profits increased 24.6% on a year-to-year basis, which is the highest growth rate in 13 quarters. Current profits in all industries of all sizes have reached the highest-ever level for the January-March quarter. Among industries, the manufacturing industry continued to see its profits improving as sales are increasing, although movement of cost reductions, such as of labor cost, came to a halt. In addition, the non-manufacturing industry continued to see its profits improving, reflecting the increase in sales. According to the BOJ tankan survey, both manufactures and non-manufactures are planning to increase in profit for three consecutive years in fiscal 2004 and expect to post a further increase in the second half of the fiscal year.
  The BOJ tankan survey also shows that business sentiment has been further improving. The diffusion index emerged from negative territory in all industries of all sizes for the first time since 1992 and is at the highest level since 1991 in large manufacturing industry.
  The number of bankrupt companies is decreasing. The number of corporate failures was less than 1,100, which is the lowest level since February 1999.

The employment situation is further improving, though some severe aspects remain.
  The employment situation is further improving, though some severe aspects remain. The unemployment rate is, while remaining at a high level, on a downward trend. The unemployment rate in May declined 0.1 percentage points from the previous month to 4.6%. The number of persons not in the labor force increased, as both of unemployed and employed persons have decreased. On the other hand, there are severe situations as the unemployment rate of age group between 15 and 24 years old is around10%.
  The number of new job offer has been flat. The effective ratio of job offers to applicants, which had been flat, increased this month. The number of employees has been on an increasing trend. Overtime hours worked in the manufacturing industry have been flat. The number of corporations saying they have excess employees, which became flat in June, has been on a downward trend as a whole.
  The underlying trend of contractual cash earnings has remained flat.

3. Prices and the financial market

Domestic corporate goods prices have been on a slight upward trend due to a rise in materials prices.Consumer prices are moving sideways.
  Domestic corporate goods prices, which have been on a slight upward trend. Breaking down the recent trend by type of goods, prices of petroleum & coal products and iron & steel, etc. have been rising due to a rise in materials prices. Import prices (yen basis) have been rising, reflecting a rise in the international commodity market and the depreciation of the yen to date. Breaking down corporate goods prices by demand-stage, there is an increasing movement in intermediate goods to pass a rise in materials prices to the goods prices, and the similar movement can also be seen in the final goods.
  Corporate services prices have remained below the levels of the previous year.Consumer prices are moving sideways. Prices of general commodities have remained generally flat, while petroleum products increased from the previous month, reflecting a rise in crude oil prices. Public utility charges have moved sideways. On the other hand, imputed rent decreased as general services prices remained generally flat.
  Although domestic corporate goods prices are rising slightly, price-boosting factors behind consumer prices may prove to be short-lived. Taken together, these movements show that the Japanese economy is in a mild deflationary phase.

Stock prices have moved above the 11,000-yen level (the Nikkei average) after rising. Long-term interest rates moved sideways.
  Stock prices, which declined in July reflecting the fall of the U.S. stock prices after rising since mid-May reflecting economic recovery, have moved above the 11,000-yen level (the Nikkei average). The yen against the U.S. dollar reflecting economic recovery, etc., slightly appreciated and has been moving in the 108-109 yen level.
  Short-term interest rates are stable. Long-term interest rates moved sideways. Enterprises' financial conditions have improved, and the yield spread between corporate and government bonds has remained at a low level.
  The growth of the monetary base has eased. The growth rate of the M2+CD money supply, which has been on a moderate upward trend since January, eased slightly in June.

4. Overseas economies

The world economy has been recovering steadily.

In the United States, the economy is expanding.
  Production has been increasing and capacity utilization rate has been rising. Against the background of these strong corporate activities, employment is increasing, which led to an improvement of consumer confidence combined with moderate increase in consumption. The economy is forecast to post a high growth rate of around 4%, as these trends are expected to continue.
  The consumer price index in May increased 3.1% from a year earlier, the highest rate of appreciation since June 2001, against the background of a high level of gasoline prices, while the core consumer price index ,excluding foods and energy, is stable. Gasoline prices, which continue to be at a high level, have been on a downward trend since the end of May.
  At its meeting held at the end of June, the Federal Open Market Committee decided to raise its target for the federal funds rate by 0.25 percentage points to 1.25% and restated that policy accommodation can be removed at a pace that is likely to be measured.

Asia has seen continued economic expansion in China and Thailand, and the economy is recovering in South Korea.
  In China, the economy has been expanding due to a steady increase in consumption and a rise in production caused by growth of exports. On the other hand, in some sectors, investment is increasing at a high level. Accordingly the measures are taken such as tight monetary policy. In Thailand economic expansion continues led by consumption and investment. In Malaysia, Taiwan and Singapore, the economies are expanding due to increases in consumption. In South Korea, the economy is recovering, with exports and production increasing.

The Euro area economy is recovering moderately, and the U.K. economy has been recovering steadily.
  The Euro area economy is recovering moderately, with the increase in exports and the moderate increase in production. In Germany, the economy is recovering moderately led by external demand. On the other hand, consumption is weak and a recovery of internal demand is delayed due to slow improvement of the employment situation. The French economy has been recovering, with consumption and investment increasing.
  In the U.K., the economy has been recovering steadily, with both consumption and housing investment continuing to increase.

International financial situations
  As for the international financial situations, stock markets in the world are moving sideways. Long -term interest rates in the United States declined, partly due to an increasing expectation that the policy rate will be raised at a slower pace and partly due to the fact that US employment statistics were weaker than expected. Long-term interest rates in other major countries have remained flat. The U.S. dollar is moving sideways.
  Oil prices, which had been on a declining trend after the OPEC ministers agreed to lift ceiling on its oil production at their extraordinary meeting in early June, have risen since the end of June.