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UPDATE 2-Japan output rises, backing case for rate hike

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TOKYO, July 30 (Reuters) - Japan’s industrial output rose 1.2 percent in June, its first increase in four months after a string of soft figures, supporting those who expect the Bank of Japan will soon raise rates.

Previously firm expectations the central bank would raise rates next month to a 12-year high have eased in recent days, due to a global market shake-out on fears of a U.S. credit crunch.

A crushing defeat for Prime Minister Shinzo Abe’s coalition in Sunday’s upper house election may also scale back market expectations for an early rate increase, analysts said.

The seasonally adjusted increase in June industrial output, compared with the previous month, beat a median market forecast for a 1.1 percent rise, thanks in part to the first increase in three months in the production of electronics parts, trade ministry data showed, and analysts saw more good news ahead.

“For July, even if we subtract the negative impact of the recent earthquake on output, which is estimated at around 0.8 percentage points, it would still be 1.0 percent and this is pretty firm,” said Takehiro Sato, an economist at Morgan Stanley.

“The latest data is supportive of a Bank of Japan rate hike,” he said.

A Reuters poll on Monday showed two-thirds of respondents still expected the Bank of Japan to raise its overnight call rate target next month, although this was down from a 79 percent expectation two weeks ago. For details, see [nTKF002812].

Swap contracts on the overnight call rate showed a roughly 50 percent chance of a BOJ rate hike in August, steady from late last week but down from more than 90 percent earlier this month.

GOOD MONTHS AHEAD?

Manufacturers forecast output would rise by 1.8 percent in July and 4.9 percent in August, which would be the highest rise since at least 2000, when the current data series began.

Leading the way are factories producing electronics parts, transport equipment and general machinery, although a trade ministry official said the forecasts were from a survey conducted before the July 16 quake in northwest Japan.

Economists say production is seen to have fallen in July as carmakers were forced to halt production temporarily after the earthquake. But they say output will likely return to a rising trend after that.

For the April-June quarter, output rose 0.1 percent from the previous quarter, prompting the ministry to maintain its assessment that production was levelling off.

Financial markets had their eyes on the global shake-out and the election defeat, rather than the data, with the Nikkei share average .N225 falling about 1 percent.

Analysts said the market issues and the threat of policy paralysis after Abe’s government lost control of the upper house could add to doubts about the timing of Japan’s next interest rate hike, but many still saw the Bank of Japan moving in August.

“Overall, the Japanese economy seems to be moving in line with the BOJ’s scenario of solid growth, so I won’t be surprised if it raises rates in August,” said Noriaki Haseyama, an economist at Dai-ichi Life Research Institute.

“But if the (political) uncertainty lasts long, it could make it tougher for the BOJ to raise rates next month.”

The BOJ has said it will need to gradually raise interest rates as the Japanese economy is expected to continue expanding, which is bound to push up prices at some point.

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