BOJ's Quarterly Tankan Survey: Improvement Seen but Failed to Alleviate Recession Worries

Japan's quarterly Tankan survey showed improved, but lower than expected, sentiment in large corporations while small firms continued to struggle in June. The brightest spots were the decline in 'inventory level for finished goods and merchandise' and improvement in financial position of large corporate.

Large manufacturer business condition DI rose to -48, worse than consensus of -43, from -58 in March while the reading for large non-manufacturer improved modestly to -29, compared with market expectation of -26 and -31 in March. For smaller companies, manufacturing and non-manufacturing DIs came in at -57 (consensus: -49, March -57) and -44(consensus: -40, March -42), respectively, signaling domestic demand remained bleak.

FY09 capex plans for all sectors in large companies were revised downward to -9.4% from -6.6% projected in March. The reading, falling short of consensus of -7.6%, signaled the weakness of Japan's export sectors. Moreover, the sharp decline in capex plans showed consistence with the leading capex indicators, which have yet to show any sign of a turnaround. We think capex will continue to trend lower through the third quarter before improvement in exports help turn it slightly better by the end of the year.

The inventory level for finished goods and merchandise DI dropped to 34 from 42, suggesting progress in inventory adjustment although the pace is slow. Moreover, the financial position DI for large corporate increased to 1 from -4. This indicated that the government's simulative monetary and fiscal policies have taken effect in relieve credit tightness.

Deflationary risk is still haunting. The manufacturing output price DI just edged 1 point higher to -24 in June, while non-manufacturing DI plunged to -26 from -21 in the previous quarter. Released last week, CPI contracted -1.1% yoy in May, a level significantly below BOJ' target of long-term price stability. We believe the central bank will continue to keep interest rate at current low level for a protracted period of time.

Although the report showed improvement in business conditions and projections in September pointed to further advance, the readings remained at low levels. We question about the sustainability of economic recovery in the Japan and believe there's risk for the world's second largest economy to deteriorate against after the third quarter if there are no signs of improvement in demand.

Japanese yen retreats against major currencies in Asia Wednesday. However, it was not driven by the Tankan survey. In fact, the currency has little change after release of the report. The yen slips to 2-wek low of 135.9 against the euro and 96.8 against the dollar after encouraging economic data released in China and Australia spurred demand for higher-yield assets. In China, PMI rose to 53.2 in June from 53.1 in May, signaling the nation's manufacturing sector has expanded for the 4th consecutive months. In Australia, retail sales rose +1% mom in May, compared with consensus of +0.5% and +0.3% in April, suggesting RBA's unprecedentedly low level of interest rate and the government's A$12B stimulus have shown impact.