Japan: Tankan Suggests Substantial Slowdown

• Today's Tankan suggests GDP growth has been solid in Q4, but could slow substantially in Q1 10 as the impact from fiscal easing starts to wane. Our forecast of 4% q/q AR in Q4 appears okay, while there could be downside on our 2% q/q AR forecast for Q1 10.
• However, the slowdown in GDP growth in Q1 next year should prove temporary. The recovery in exports appears to be on track and private consumption is expected to get another boost both from fiscal stimuli from Q2 10 and continued improvement in the labour market.

Tankan consistent with solid Q4, however Q1 10 looks weak

Business sentiment for large enterprises generally came out better than expected for both manufacturers and non-manufactures. As seen in the chart current conditions continued to improve and are expected to improve further in Q1 10, although the pace of the improvement is expected to slow. However, as seen in the chart there is currently a large divergence between large and small enterprises in the Tankan survey. While business conditions for small enterprises also improved in Q4, small enterprises contrary to large enterprises expect business conditions to deteriorate in Q1 10. This is particularly case for non-manufacturers. This development reflects that domestic demand, not least private consumption has started to slow as the impact from fiscal easing has started to wane.

Capital expenditure plans for the current financial year 2009 (FY 09, ending March 2010) came in slightly weaker than expected at minus 13.8 y/y (consensus: minus 11.8). However, this largely reflects that business capex has been weak in H1 09, while capex plans for H2 10 have actually been revised slightly higher. As seen in the chart it appears the development in Tankan is consistent with our view that capex expenditure is currently bottoming out.

Overall Tankan does not suggest increasing deflationary pressure. The finished goods price component improved more than the input price component, indicating margins have improved in Q4. This is consistent with businesses overall revising their profit forecast higher for FY 09 in the Tankan survey (from minus 20.9% to minus 16.1%). The average predicted JPY/USD exchange rate for H2 09 is 91.6 (it was 94.08 in previous survey.

Increasing downside risk on our GDP forecast

The development in Tankan is consistent with very strong growth in Q4, but suggests a substantial slowdown in Q1 next year. Current conditions for all industries and all enterprise sizes suggest GDP growth of about 5% q/q AR in Q4 AR (see chart). However, Tankan suggests a substantial slowdown in Q1 next year, with growth possibly returning to negative territory. This slowdown is expected to be mainly driven by weaker private consumption as the impact from fiscal easing starts to wane. The recovery in industrial production appears to remain on track although the pace of the recovery is expected to slow next year.

Development is consistent with our 4% q/q AR GDP forecast for Q4, while there could be downside on our 2% q/q AR GDP forecast for Q1 10. The weakness in domestic in Q1 10 should prove temporary, as another fiscal stimulus package should boost private consumption from Q2 10 and business investment should gradually start to recover.

Danske Bank
http://www.danskebank.com/danskeresearch

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