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.

"For the moment there is a 50-50 chance," he said. "A temporary lull, at least, is highly likely."

A SLOWDOWN IN EXPORTS FEARED

With tame wages keeping a lid on spending by Japanese consumers, exports have largely driven growth in Japan, the world's second-largest economy, and there are signs they are losing steam.

Overall growth in exports has slowed, and sales to the United States decreased 4.5 percent in December from a year earlier, marking the fourth straight month of declines as the slowdown there hit Japanese auto output.

The troubles may not come solely from the United States.

The International Monetary Fund cut its 2008 forecast for world growth to 4.1 percent from 4.4 percent in January as the impact of the U.S. subprime housing crisis is seen spreading around the world.

Finance leaders from the Group of Seven top industrialised nations turned pessimistic on the global economy when they met in Tokyo last weekend, acknowledging that far more work was needed to prop up markets and sustain global growth. [ID:nT262281]

"If global growth slows to below 3 percent, the Japanese economy will also lose steam," said Chotaro Morita, chief strategist at Barclays Capital. He expects Japan to avert a recession but says a moderate slowdown is likely this year.

Japan's government, which defines economic cycles by calculating a range of indicators including stock prices, says Japan is enjoying its longest growth cycle since World War Two.

Japan's economy grew by a surprisingly robust 0.9 percent in the last quarter of 2007, government data showed on Thursday, sending Tokyo stocks to a one-week high. [.T]

The growth works out to an annual rate of 3.7 percent, well above the 0.6 percent annual pace in the United States in that quarter, but analysts said outlook for Japan's economy is dim.

WEAK CONSUMPTION

"The GDP growth rate in January-March will likely fall to near zero with the possibility of it turning negative," said Tetsufumi Yamakawa, chief economist at Goldman Sachs.

He also has said the Japanese economy may already be in recession, citing slowing export growth and sluggish consumption, which makes up the lion's share of the economy.

Japan has its own housing problem, although that is related to tighter building rules introduced last year that hampered new construction. Housing investment fell 9.1 percent in the October-December quarter.

The BOJ is holding a policy-setting board meeting that ends on Friday and is expected to keep its key overnight call rate on hold at 0.5 percent. [ID:nT297598] (Editing by Mike Miller)