Japan industrial output falls, rate view unchanged

TOKYO (Reuters) - Japanese industrial production fell for the second month in a row in February, underscoring the bleak economic outlook and reinforcing market views that the Bank of Japan may be forced to cut interest rates this year.

The widely watched production figure is seen as key to Japan's growth outlook, which has suffered as the subprime mortgage crisis derails U.S. demand for Japanese goods.

A 10 percent rise in the yen against the U.S. dollar this year has added to concern that Japan's big export industries may suffer, although a government official said manufacturers had not reported a major impact on production yet from the yen's jump to a 13-year high.

Industrial output fell 1.2 percent in February, the trade ministry said, less than the median market forecast for a 2.1 percent drop, as production was firmer than expected among makers of machines and chemical products. [JPIP1=ECI]

But economists said the smaller fall did not give much comfort. [nT339530]

"The reason the fall was smaller than expected is because companies have been prepared themselves for slowing demand," said Susumu Kato, chief economist at Calyon Securities.

"Companies have been fine-tuning production levels by looking at demand. So they don't have excessive inventories," he said, adding that production may remain sluggish but is unlikely to fall sharply, either.

Manufacturers said they expected their output, the core component of production, to rise 2.0 percent in March but to decrease 1.0 percent in April.

Financial markets showed little reaction to the data but fresh concerns over the U.S. economy and the global credit crisis sent Japanese share prices down more than 2 percent.

In the first three months of this year, the Nikkei share average .N225 has shed 18 percent, its worst performance since a recession in 2001.

Also weighing on the economy is policy paralysis in parliament that has left the central bank without a permanent governor amid growing speculation that Prime Minister Yasuo Fukuda may lose his job. [nT18431]

Fukuda said on Saturday that downside risks were rising in the Japanese economy and it was important for industrialised nations to be ready to take aggressive steps as needed. [nT7914]

WORST YET TO COME?

Economists warn that a faltering U.S. economy has slowed down assembly lines at many Japanese factories as exports to the United States have declined for the past six months.

So far, strong exports to Asia, Europe and other developing countries have cushioned the blow and helped keep the Japanese economy growing until the last quarter of last year.

Still, there are lingering concerns that the U.S. subprime crisis, coming on top of soft Japanese consumer spending, could send the world's No.2 economy into recession.

Production in the electronics parts and devices industry -- one of Japan's leading industries -- fell 4.1 percent in the month, the largest fall since October 2004.

Some companies in the electronics devices industry reported that Chinese markets were dealing with an oversupply of some of their products, a senior government official said, a possible sign of falling U.S. demand.

Many Japanese companies export machine parts to Chinese plants for processing and re-export to final consumer markets including the United States.

The Bank of Japan has been increasingly cautious in its outlook, although it has maintained a view that the economy will emerge from the current soft patch to resume moderate growth.

The bank's policy board members, who meet to review rates next week, have also suggested recently that a rate cut would not be on the table in the near future.

Investors are pricing in about a 50 percent chance of a rate cut by the end of the year MIRS6, although many market players do not see much chance of any rate move in the near term.

The NTC Research/Nomura/JMMA Purchasing Managers Index, which gives an early snapshot of the health of manufacturing, declined in March -- its first fall in five months, other data showed.

However, while industrial output faltered, long-suffering wage earners are starting to see more money in their pockets.

Japanese wages rose 1.3 percent in February from a year earlier due partly to a rise in full-time workers, other data showed, while overtime pay saw its fastest growth since 2006.

The survey also showed the number of general employees rose 2.4 percent, the fastest increase since June 1992.

Wages have been firm so far this year after falling in most months last year.

"The rise this year may be exaggerated due to sampling problems. But on the whole, wages seem to be improving," said Junko Sakuyama, an economist at Dai-ichi Life Research.

Japanese housing starts in Japan, which had been hit hard by a regulatory change last year, fell 5.0 percent in February from a year earlier, a bigger fall than a median forecast of a 1.5 percent drop, government data showed. [JPHST=ECI]

Japan's housing starts fell sharply in the second half of last year after the government tightened building rules.

(Additional reporting by Yuzo Saeki and Tetsushi Kajimoto)