Japan Headed for `Mild Recession' in 2008, Morgan Stanley Says

-- Japan's economy is headed for a ``mild recession'' that could be worsened should a bigger-than- expected U.S. slowdown halt the nation's export-led expansion, Morgan Stanley said.

``It's time to buckle up,'' Takehiro Sato, chief Japan economist at the investment bank, said in a report yesterday. Sato cut next year's growth estimate for Japan in half, saying ``errant'' government policy has hurt consumers and the building industry at home, and credit problems stemming from the subprime- mortgage crisis will stifle demand from abroad.

The world's second-largest economy is becoming more dependent on overseas markets just as world growth looks set to slow. Policies meant to protect homeowners from building fraud and borrowers from predatory lenders have hurt an economy that's already struggling with falling wages and record gas prices.

``The foreign-demand growth scenario for Japan's economy appears to be approaching a tipping point,'' Sato said. ``Coming on top of high energy prices, the fallout from the subprime crisis and errant policies will likely cause economic activity to stagnate.''

Sato slashed his 2008 growth estimate to 0.9 percent from 1.9 percent a month ago. He considers growth of less than 1 percent ``for an extended period,'' to constitute a ``mild recession.''

A U.S. recession, combined with higher oil prices and yen gains could cause Japan's growth to ``slide to zero,'' he said, giving that scenario a one-in-three chance.

Reports last week suggest Japan's expansion is already cooling.

Energy Costs

The economy grew more slowly than the government initially estimated in the third quarter and profits fell for the first time in five years because higher energy costs wiped out margins at small and mid-sized companies, where 70 percent of Japan's workers are employed.

Rising raw material costs already make it ``tough for firms to pay higher wages,'' Sato said. Consumer confidence plunged to the lowest level in almost four years in November, the government said yesterday.

The Bank of Japan's quarterly Tankan business survey on Dec. 14 will probably show a drop in sentiment of large manufacturers for the first time since March, according to economists surveyed by Bloomberg News.

Exports, led by shipments to Europe and China, accounted for almost all of the country's annualized 1.5 percent growth in the three months ended Sept. 30.

Government Regulation

Housing starts plunged 35 percent in October and fell to 40- year lows in the previous two month, after the Land Ministry tightened rules for building permits, causing a log-jam in applications. The change was made after architect Hidetsugu Aneha in 2005 admitted to skimping on steel in dozens of hotels and condominiums.

Other well-intended regulations capping the interest rates that consumer-finance companies can charge and requiring banks to be more thorough in explaining the risks of mutual fund investment have also taken a toll on growth, Sato said.

``Just to be clear, we don't think the objectives of these policies is misguided, but hasty moves by bureaucrats to implement such laws, without regard for the economy, have had a considerable impact,'' he said.

Slower growth will prompt the Bank of Japan to postpone raising the benchmark interest rate from 0.5 percent until the third quarter of 2009 and increases the risk of a cut, Sato said.

``A rate cut is a bigger risk than a hike,'' he said. The bank will keep its key rate, the lowest among major economies, on hold until the second quarter of 2008, according to 21 of 30 economists surveyed by a government think tank.

U.K. Unemployment Drops to the Lowest Since 1975 (Update4)

-- U.K. unemployment fell more than twice as much as forecast to the lowest since 1975 in November as the strength of the economy encouraged companies to take on more workers.

Claims for jobless benefits dropped 11,100 from October to 813,000, the Office for National Statistics said today in London. The median forecast in a Bloomberg News survey of 30 economists was for a decline of 5,000. The jobless rate, at 2.5 percent, matched a 32-year low.

Britain's economy will expand 3.2 percent in the fourth quarter, continuing the strongest growth streak in seven years, before a ``sharp'' slowdown next year, the Bank of England forecasts. The central bank trimmed its key lending rate last month, anticipating that a surge in market borrowing costs will trigger a slump in the U.K. and weaken the labor market.

``This suggests that the economy is robust and the credit crisis hasn't had a severe impact on employment so far,'' said Jeavon Lolay, an economist at Lloyds TSB Group Plc in London. ``We still see two rate cuts next year.''

Bank of England policy makers forecast economic growth of just above 3 percent this year, the fastest since 2004, and for that to slow to around 2 percent next year. They cut the benchmark rate a quarter point to 5.5 percent on Dec. 6 as a surge in credit costs stemming from the collapse of the U.S. subprime mortgage market showed signs of constraining expansion.

Brown Comments

Prime Minister Gordon Brown, who is trying to revive his administration's popularity, boasted about the jobs figures in Parliament today.

``We've got the fastest-growing economy in Europe and that's why today's employment figures are so good,'' he said. ``That's what a Labour government is about.''

The unemployment rate as measured by International Labour Organization standards was 5.3 percent in the three months through October, the lowest since the first quarter of 2006. The rate compares with 7.2 percent in the 13-nation euro region, 4.7 percent in the U.S., and 4 percent in Japan.

``The U.K. data have held up well, but we see a sharp slowdown in 2008,'' Sarah Hewin, a senior economist at American Express Bank in London, said in an interview. ``Inflation is now above target and will stay there a few months, but we see it coming back down.''

The pound was little changed after the report, trading at $2.0438 as of 12:21 p.m. in London. Against the euro, the pound was at 71.857 pence after touching a four-year low last week.

`Hardship Ahead'

Policy maker David Blanchflower said Nov. 29 there is a risk that unemployment may increase as economic growth slows and that there may be ``hardship ahead'' for Britons facing higher mortgage costs when lower fixed rates for their loans end.

London financial institutions may cut about 6,500 banking and fund-management jobs next year, and trim bonuses by 16 percent, as economic growth in the U.S. and China slows, the Centre for Economic and Business Research Ltd. said Oct. 8.

Members of the central bank's monetary policy committee have said they are watching salary agreements for signs that gains in consumer prices are getting entrenched in the economy. Inflation was 2.1 percent in October, above the 2 percent target for the first time in four months.

Inflation Risks

Policy makers' economic forecasts assume ``real take-home pay growth remains well contained, but grows more rapidly than it has over the past three years,'' the bank said Nov. 14. Deputy Governor Rachel Lomax said Nov. 29 risks to inflation included the upcoming ``big season of pay awards.''

Record migration, which swelled the workforce to a record 31.6 million in September, has still kept a lid on pay.

Average earnings including bonuses rose an annual 4 percent in the three months through October, down from 4.1 percent in the period through September, the statistics office said today. Without bonuses, wage growth slowed to 3.6 percent from 3.7 percent in the third quarter.

``The bank will be reassured that wage growth hasn't picked up,'' said Lloyds TSB's Lolay. ``Given that the labor market is tight, they must remain concerned about pay.''

The U.K.'s Health and Safety Executive said on Dec. 10 it raised its pay for new nuclear safety inspectors to compete with other parts of the atomic energy industry, as it tries to hire staff to assess reactor designs that may be built in Britain.

Fed Bypasses Procedures to Gain Auction Authority in Rare Move

- The Federal Reserve took advantage of emergency powers to authorize the auctions that officials felt were necessary to ease a credit squeeze, concluding it otherwise lacked legal permission to do so.

The Fed bypassed requirements for prior notice and public comment when writing the regulations to implement today's agreement with the European Central Bank and three other central banks. The Fed's official notice today said any delay caused by following standard procedures would have been ``contrary to the public interest.''

Such actions, while used ``sparingly'' over the years, were justified today because the new rules probably carry few costs, a former Fed attorney said. The action today was part of a coordinated effort with other central banks to alleviate a global growth slowdown, acting after interest-rate cuts failed to allay concerns that banks will reduce lending.

``It's something that they normally don't do,'' said Oliver Ireland, who worked as a Fed counsel for more than two decades and is now a partner at Morrison & Foerster in Washington. ``If you look at doing things to stabilize volatile markets, I don't think it's very hard to find good cause. There's no tangible harm to anybody.''

The Fed uses the bypass powers regularly when changing the rate on direct loans to banks, though rarely when publishing broader rule changes. The Administrative Procedure Act requires federal agencies to give public notice and solicit comments on regulatory changes though with exceptions, Ireland said.

`Good Cause'

Such notice wasn't needed in this case, the Fed said, because the decision relates to ``public loans'' and because there's ``good cause'' to justify no delay. Any wait in adopting the rule changes would be ``impracticable, unnecessary and contrary to the public interest.''

In addition, any advance notice may have spoiled the relative surprise the Fed and its counterparts delivered today.

It's not the first time Fed officials have taken unorthodox steps to prevent word of an upcoming decision from leaking. In August, St. Louis Fed President William Poole skipped an emergency conference call among policy makers and kept dinner plans with university professors and students to avoid any hint the central bank was going to cut the discount rate and revise its economic outlook the next day.

The Fed said that today's changes would be temporary and end on an unspecified date. If officials sought to make them permanent, the central bank would seek public comment.

``In general, we would like for the Fed and other regulatory agencies to solicit comments, but given the circumstances, it was important to move quickly,'' said Keith Leggett, senior economist at the American Bankers Association in Washington.

Fed Historian Meltzer Says Greenspan Is `Too Easy on Himself'

Dec. 12 ( -- Former Federal Reserve Chairman Alan Greenspan ignored warnings about the Fed's low interest rates that fueled real estate speculation and the current housing recession, said Allan Meltzer, professor of political economy at Carnegie Mellon University in Pittsburgh.

``I think he lets himself off much too easy,'' said Meltzer, author of a 2002 book on the early history of the central bank, in an interview. ``He acknowledged maybe his policy had a little bit to do with it. But he found all kinds of other reasons'' to blame for the housing and mortgage problems today.

Greenspan, in a Wall Street Journal commentary today, said lowering the Fed's target interest rate to 1 percent in 2003 may have contributed to higher home prices by prompting demand for adjustable-rate mortgages, though the impact was ``not major.'' He said the Fed was worried about deflation.

Meltzer said he met then with Greenspan at the former chairman's invitation and disagreed with the concern over deflation.

``I said, `Alan, we have had six or seven deflations in the United States in the history of the Federal Reserve, and only one of them ever had terrible consequences, and that was 1929 to 1933,''' he said. ``That was because deflation was not only bad, but because the money growth was lower and lower and lower, so the expectation was deflation would continue. In all the other six, nothing happened.''

Greenspan ``continued to believe that deflation was the problem. He was wrong about that, simply out and out wrong,'' Meltzer said.

Yen Near One-Month Low as Central Banks to Provide Liquidity

Dec. 13 -- The yen traded near a one-month low against the dollar after central banks led by the Federal Reserve announced a joint effort to ease the credit squeeze by encouraging short-term lending among financial institutions.

The New Zealand dollar and the South African rand rose yesterday while the yen and Swiss franc declined as the central banks' move prompted purchases of higher-yielding assets with loans from countries with low interest rates, known as carry trades. A global liquidity injection may stabilize the money market and help the U.S. economy avoid a recession.

``The bias is for the yen to weaken and higher-yielding currencies to gain,'' said Hideki Amikura, deputy general manager of foreign exchange in Tokyo at Nomura Trust & Banking Co. Ltd., a unit of Japan's largest brokerage. ``Credit markets may hold out at the end of the year and the U.S. economy's prospects could improve. We may have hit bottom.''

The yen traded at 112.15 per dollar at 8:35 a.m. in Tokyo from 112.24 yesterday, when it fell to a one-month low of 112.47. Japan's currency traded at 164.97 per euro, following yesterday's 1.8 percent drop, its largest in a month. The dollar traded at $1.4707 per euro and 1.1347 Swiss francs.

Yesterday's drop in the yen eclipsed a rally on Dec. 11 when traders dumped stocks and higher-yielding currencies on speculation the Fed's interest-rate cuts weren't enough to keep the economy from contracting.

Funding `Squeeze'

The currencies of New Zealand, South Africa and Australia gained about 2 percent or greater versus the yen yesterday as investors returned to so-called carry trades. Against the dollar, the New Zealand currency rose 2 percent while the Australian currency strengthened 1 percent.

The Fed will provide cash to banks through up to $40 billion in two auctions this month and will provide $24 billion in currency swap lines to the European and Swiss central banks.

``The newspapers are pushing the idea that we're going to have a recession, maybe a big one, and there isn't any real evidence of that,'' said Allan Meltzer, professor of political economy at Carnegie Mellon University in Pittsburgh.

``This is not a crisis and the Fed is being pushed into doing things that it has every reason to know lead them down the wrong path,'' according to Meltzer, author of ``A History of the Federal Reserve, Volume 1, 1913-1951.''

The Fed on Dec. 11 lowered its benchmark overnight rate a quarter-percentage point to 4.25 percent, in line with the median forecast in a Bloomberg survey. It dropped the discount rate, the rate it charges banks for direct loans, by a quarter- point to 4.75 percent. Some analysts had called for a larger discount rate cut to counter the drop in bank lending.

Franc Drops

The Standard & Poor's 500 index rose 0.6 percent, paring a gain of as much as 2.3 percent earlier. The index sank 2.5 percent on Dec. 11. Treasuries fell as demand for the safety of government debt diminished. Crude oil surged 4.8 percent on speculation the central banks' actions will spur global growth.

The Swiss franc, another funding currency for the carry trade, fell against 11 of the 16 most-traded today.

``There's a restored confidence in the market,'' said Mark Meadows, strategist at currency-trading company Tempus Consulting Inc. in Washington. ``The Fed is making a lot of moves to ensure the U.S. economy doesn't decline substantially.''

In carry trades, investors get funds in a country with low borrowing costs and buy assets where rates are higher, earning the difference. The risk in this strategy is that exchange-rate swings erode gains from yield differentials.

Wider Yield Difference

The Bank of Japan's benchmark rate is 0.5 percent, the lowest among industrialized nations, compared with 8.25 percent in New Zealand and 6.75 percent in Australia. Switzerland's rate is 2.75 percent.

The U.S. currency has lost 10 percent against the euro this year as the Fed's rate cuts dimmed the allure of dollar- denominated assets. Two-year German government debt yielded 0.90 percentage point more than similar-maturity Treasuries. The gap reached 0.98 percentage point this week, the widest since 2003.

The move by the Fed, the ECB, the Bank of Canada, the Bank of England and the Swiss National Bank comes as the collapse in the subprime mortgage market has crimped banks' willingness to lend to each other, threatening to tip the U.S. economy into recession.

The Fed's first auction of term funds will be $20 billion on Dec. 17. The second, on Dec. 20, will provide up to $20 billion. The central bank plans two more auctions in January, with possible additional operations thereafter, the Fed said.

Japanese Futures Rise on Weaker Yen, Fed's Liquidity Injection

Dec. 13 -- Japan's Nikkei 225 Stock Average futures rose in Chicago after the yen weakened against the dollar and the U.S. Federal Reserve spearheaded the biggest injection of liquidity into financial markets in six years.

U.S. traded receipts of Sony Corp. climbed from the closing share price in Tokyo yesterday. The Fed said it will provide up to $24 billion in funds to European central banks as well as loan auctions that will add up to $40 billion into the system.

``The yen has fallen back, helping market sentiment,'' said Mitsushige Akino, who oversees $468 million in assets at Ichiyoshi Investment Management Co. in Tokyo. ``The Fed's plan looks like it will assist in avoiding a financial-market credit crunch.''

Nikkei 225 futures expiring in December closed in Chicago at 15,920 yesterday, up from 15,910 in Osaka and 15,890 in Singapore earlier the same day. The Bank of New York Japan ADR Index, which tracks the nation's American depositary receipts, climbed 1.2 percent.

Advances were limited as Bank of America Corp. and Wachovia Corp. said credit losses will widen, heightening concern the Fed's actions may not be enough to stem the worsening condition of financial companies.

Mitsubishi Corp. may lead gains by oil-related shares after the price of crude soared by the most since January.

U.S.-traded receipts of Sony, the world's second-largest maker of consumer electronics, advanced 0.5 percent from the closing share price in Tokyo yesterday. Those of Honda Motor Co., which had 55 percent of its sales in North America last year, added 0.1 percent.

Fund Injection

The yen recently weakened to 112.16 versus the dollar from 111.04 at the close of trading yesterday in Tokyo. A weaker yen increases the value of Japanese exporters' dollar-denominated sales when converted into local currency.

The Fed said yesterday it will make funds available to the European Central Bank and Swiss National Bank to increase the supply of dollars in Europe. The Fed also plans four loan auctions, including two this month, for U.S. financial institutions.

The central banks' actions are a response to a surge in short-term borrowing costs as banks have been reluctant to lend to each other. The three-month dollar London interbank offered rate, a gauge followed by central bankers, rose to a two-month high of 5.15 percent a week ago even as some central banks have lowered their benchmark rates during the past four months.

Meanwhile, Bank of America, the second-biggest U.S. bank, said yesterday it expects writedowns to increase and ``weak'' earnings through the first quarter of next year. Wachovia, the fourth biggest, said it may double its loan loss provisions.

Nippon Steel, Toshiba

Mitsubishi Corp., Japan's largest trading company, and Mitsui & Co., the No. 2, get most of their profits from commodities dealing. Inpex Holdings Inc. is Japan's biggest oil explorer.

Crude oil for January delivery jumped 4.9 percent to $94.39 a barrel in New York, the biggest one-day gain since Jan. 30.

Nippon Steel Corp., the world's second-biggest producer of the alloy, may advance after the Nikkei newspaper reported the company may expand high-grade steel capacity at a factory in Japan.

Toshiba Corp., the world's second-biggest maker of flash memory chips, may climb after the Nikkei said the company has developed technology that will allow it to build 100 gigabit NAND flash chips.

Yesterday, the Nikkei fell 0.7 percent to 15,932.26 and the Topix index declined 0.6 percent to 1,556.93.