Japan Out of the Game?

Japan's economy grew at a weaker than expected 0.1 percent in the April-June quarter as exports to the United States slowed and consumer spending declined, the Cabinet Office said Monday.

The expansion in gross domestic product marks the 10th consecutive quarter of growth but corresponds to an annual pace of just 0.5 percent. Economists were expecting an annual pace of about 1 percent.

In nominal terms, which excludes price changes, the economy grew 0.3 percent in the quarter.

The slower growth and global liquidity squeeze make it less likely the Bank of Japan will raise interest rates next week, economists said. The economy grew 0.8 percent in January-March and 1.3 percent in October-December of 2006.

GDP measures the value of all goods and services produced in an economy and is considered the best barometer of a country's economic health.

The weak data came out as the Bank of Japan was preparing to discuss interest rates at its two-day Policy Board meeting starting Aug. 22.

A slowdown in GDP does not necessarily pose a hurdle to an interest rate hike, but last week's shakeout in global markets — triggered by the woes of the subprime mortgage market in the United States — will force the central bank to think twice, economists said.

"The figure was a bit lower than we expected and reflects a short-term economic slowdown," said Makoto Ishikawa, a senior economist at Japan Research Institute in Tokyo. "The U.S. subprime mortgage crisis and its impact on the (global) market will work against the central bank's intention to raise interest rates this month."

Ishikawa said the central bank will have to make a tough decision, one that will depend on how the markets react over the next 10 days. He says the chances of a rate hike are now about 50-50.

Heightened concerns over the U.S. mortgage market prompted the world's top central banks to inject massive amounts of funds into the global financial system to bolster confidence and avert a global credit crunch.

Following the moves of the U.S. Federal Reserve and the European Central Bank, the Bank of Japan pumped ¥600 billion into the financial system Monday after making a ¥1 trillion injection Friday. The Australian and Canadian central banks made similar moves last week.

The situation has spawned growing speculation that the Fed may cut interest rates and the ECB will put off further rate hikes.

Exports, one of the main drivers of Japan's GDP, expanded just 0.9 percent in April-June quarter compared with 3.4 percent the previous quarter. Imports grew 0.8 percent, down slightly from 0.9 percent in the January-March quarter.

Consumer spending, which accounts for more than half of all economic activity, grew only 0.4 percent in the reporting quarter, or half the previous quarter's pace, as consumers tightened their purse strings after local income taxes rose in June.

Wages also continued to decline despite a drop in unemployment. The jobless rate in June fell to a nine-year low of 3.7 percent, but average monthly wages — including overtime and bonuses — dropped 1.1 percent in June.

Capital spending, the other key engine of the nation's economic recovery, expanded at a rate of 1.2 percent, improving from just 0.3 percent the previous quarter.

The GDP deflator, a broad reflector of price movements, declined 0.3 percent year-on-year as it did the previous quarter. The domestic demand deflator, considered a key measure of national price trends, rose 0.2 percent, marking its third rise in nine years.

Economic and Fiscal Policy Minister Hiroko Ota said at a news conference in Tokyo that the end of deflation remains in sight.

"Japan's economic recovery will continue led by domestic demand," Ota said, pointing to solid corporate earnings.

But economists said that falling wages and other weak figures indicate more problems ahead.

"The tax burden worsens consumers' spending sentiment, and the falling wages and declining unit labor costs are reducing inflationary pressure," said Yasunari Ueno, chief market economist at Mizuho Securities. "The latest GDP data also show how Japan still relies heavily on foreign demand."

Core consumer prices, excluding fresh food, dropped 0.1 percent in June from a year earlier, marking their fifth consecutive monthly drop.

"Japan is expanding its export portfolio to include emerging markets and other countries, so even if exports to the U.S. take time to rebound, I am not worried about it," Japan Research's Ishikawa said. "Instead, the moves of the U.S. stock markets affect things here, so a decline in stock prices may lead consumers to spend less as they lose money, and the stock market is a leading indicator of the economy."