Japan economy may shrink in the first half of '08

By Yuzo Saeki

TOKYO, Feb 14 (Reuters) - Slowing industrial production, a sharp drop in housing investment and a clouded outlook for consumption all point to economic contraction in Japan in the first half of this year.

Even after Japan posted surprisingly strong growth in October-December, a slowdown in the U.S. economy in the wake of the subprime mortgage debacle could take a toll on Japan's exports and output, analysts said, keeping alive speculation that the next move by the Bank of Japan may be to cut rates.

"There are two main risks: the U.S. economy's slowdown becoming more severe than expected, and the weak business conditions among Japan's small firms hitting jobs," said Takahide Kiuchi, chief economist at Nomura Securities.

Many analysts said Japan will likely avert a recession -- using the widely quoted definition of two consecutive quarters of contraction -- but they said Japan's longest postwar growth cycle, calculated with economic indicators that show activity momentum, may have ended.

Analysts in Japan look at industrial output as a major indicator of the economy's direction, since its movements usually coincide with the government's assessment on economic cycles.

Japanese industrial production, whose moves depend largely on overseas demand, logged a less-than-expected 1.4 percent rise in December, and manufacturers expected their output to fall in January and February.

"Industrial production could have peaked in October-December and started to fall in January-March," said Takehiro Sato, senior economist at Morgan Stanley. "In such a case, there is a possibility that Japan will follow the United States into a recession in the first quarter."

Yasunari Ueno, chief market economist at Mizuho Securities, said a rise in inventories in first-quarter industrial production would significantly increase the likelihood of a contraction as it would point to lower output down the road.