UPDATE 5-Japan business sentiment firm, supporting BOJ move

Mon Jul 2, 2007 5:45am EDT

* Click on [ID:nT321591] and [ID:nT236255] for tables of key figures in the tankan survey, and [ID:nT342908] for highlights.

(Adds details, total cash earnings data)

By Tetsushi Kajimoto

TOKYO, July 2 (Reuters) - Big Japanese firms remain upbeat about business conditions but small companies are less optimistic as they have trouble passing on rising raw materials prices to consumers, a Bank of Japan survey showed, supporting views the central bank will stick to its slow pace of raising rates.

The closely watched quarterly tankan, or short-term economic outlook, came after Friday's soft reading on Tokyo area consumer prices, which had boosted expectations for the BOJ to raise rates only gradually and dispelled talk of a rate hike this month.

The yen initially fell against the dollar JPY= but reversed later on expectations of inflows from overseas bond redemptions. Similarly, Japanese government bond futures 2JGBv1 first hit a three-week high but later pulled back.

"Ultimately I don't think this is going to change the BOJ's basic stance," said Hiroshi Shiraishi, an economist at Lehman Brothers Japan.

"They will see this report as suggesting that decent economic growth is continuing and a gradual tightening will be necessary, although there's nothing really here to suggest the economy is overheating."

The tankan released on Monday showed a headline diffusion index (DI) for big manufacturers' sentiment of plus 23, matching the market's median forecast and unchanged from the previous survey in March, when it fell from 25 in December -- the highest since September 2004.

The DI for big non-manufacturers stood at plus 22 for June, also matching the consensus forecast and staying at a 15-year high hit in December last year.

The DI for smaller manufacturers came to plus 6, down from plus 8 in March and slightly below the consensus forecast of plus 7, while their outlook index for September was seen at plus 4, lower than the consensus forecast of plus 7.

"Small firms are having trouble passing on higher raw materials costs to consumers, even in sectors such as electric machinery and automobiles that enjoy solid profits," said Takumi Tsunoda, economist at Shinkin Central Bank Research Institute.

The yen's weakness is helping big firms boost exports but dragging on smaller firms as it has inflated their import bills for raw materials, economists said, underlining the case that the big companies' strength has not spilled over to small ones.

Separate data also showed on Monday that Japanese wage earners' total cash earnings fell from a year earlier in May for the sixth straight month, a sign that companies remain slow in passing on their strong earnings to households.

CAPEX SLOWING

Market players had been eagerly awaiting the June tankan for clues on whether the BOJ will raise rates to a 12-year high of 0.75 percent in August, as widely expected by markets.

Many analysts expect the BOJ board to keep policy settings unchanged at its meeting on July 11-12. The central bank has kept rates steady since raising the key policy rate to 0.5 percent in February, which was the first rate hike since July last year.

Traders were also focusing on capital spending plans by Japanese firms in gauging the strength of the corporate sector, a key driver of the world's second-largest economy, which is experiencing its longest growth cycle in the postwar era.

The tankan showed big firms expect their capital spending to rise 7.7 percent in the current fiscal year ending next March, compared with the market's median forecast for an 8.8 percent rise and the 2.9 percent increase seen in the previous survey.

"The growth in corporate profits and capex is slowing from last year. But considering their strength last year, that is not surprising and there's no reason to be too pessimistic about the economy," said Taro Saito, a senior economist at NLI Research.

In a sign of steady capital spending, Sony Corp. (6758.T) has announced a plan to spend about 60 billion yen ($490 million) over the next three years to boost its capacity to make image sensor chips.

Fanuc Ltd. (6954.T), an industrial robot maker, said last month it would build a new plant in Japan to boost its output of control units used in machinery tools by 75 percent.

The tankan showed that big manufacturers' outlook index for September was seen at plus 22, showing that they expect business conditions to worsen slightly over the next three months.

The outlook DI for big non-manufacturers stood at plus 23 in the survey that covered 10,839 companies, of which 2,469 were categorised as large. It was conducted from May 28 to June 29.

The diffusion index is calculated by subtracting the percentage of companies that consider conditions to be unfavourable from those that see them as favourable. A positive number means optimists outnumber pessimists.

(Additional reporting by Leika Kihara and Yoko Nishikawa)

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