JAPANESE ECONOMY Mixed scenarios regarding corporate earnings... 1

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1 JAPANESE ECONOMY Mixed scenarios regarding corporate earnings... 1 US ECONOMY The U.S. economy remains steady Second quarter current account deficits fell to $19.7 billion EUROPEAN ECONOMY U.K. growth rate fell to 1.% yoy in the second quarter.. 4 CHINESE ECONOMY An increase in inventory may be a reason for the rise in metal exports.... This is an abstract of our monthly reports on the Japanese, U.S., European, and Asian economies, translated and edited by Mariko Noda (ndmariko@ufji.co.jp), with the assistance of Chisa Hiro. The information and the views contained herein are subject to change without notice. Economic Research Department

2 JAPANESE ECONOMY Mixed scenarios regarding corporate earnings By Akihiko Suzuki, Senior Economist The DIs for Business Conditions (percentage points of favorable minus unfavorable ) regarding large manufacturers improved by 1 point from the previous survey, according to the BOJ s Tankan September survey published on October 3rd. A bullish newspaper article stressed that this was the second consecutive quarter of an improvement, while a bearish newspaper article commented that the DIs remained mostly unchanged. The evaluation varied among media. In fact, the global economy is maintaining a fine balance between a recovery and a global change in price structure. The shift is caused by a surge in commodity prices, such as oil prices, for the first time since the first and second oil shocks. The same situation holds for the Japanese corporate sector. Companies expect a rise in sales due to a recovery in the global economy, but there is the negative effect of an increase in the costs of raw materials, such as oil. As long as there are mixed predictors, economic forecasts will not be either too optimistic or too pessimistic. One positive predictor is a production trend in digital related goods, such as semiconductors and LCDs. As a necessary adjustment in inventory has been completed, it is likely that production will resume rising after an interval. August industrial production rose by 1.2% on a month-on-month basis (mom), led by a 9.9% mom rise in the production of electronic parts and devices. Shipments also rose by 1.7% mom, and production is expected to expand by 3.% mom in September, led by electronic parts and devices, and auto industries, according to the Survey of Production Forecasts in Manufacturing. An improvement in the DIs for Business Conditions of the processing industry may indicate the expectation for a recovery in shipments. Japan: Industrial production (Year of 2=1, seasonally adjusted Production Shipment Inventory Note: Cross marks indicate forecast figures based on the Forecast Survey. Shaded areas indicate the recession period, according to the Cabinet Office. Source: Ministry of Economy, Trade and Industry UFJ Institute Economic Research Dept. Global Watch October 2 1

3 But a rise in raw material costs, a negative predictor, reflected an increase in the value of imports; Japan depends heavily on imported resources. Import values rose by 1.9% on a year-on-year basis (yoy) in 24. They continue to rise at a yoy two-digit base in 2, increasing by 21.2% yoy in August. Imports of mineral fuels, mainly crude oil, expanded by 8% yoy. Part of the income transfer from Japan to oil exporting countries is borne by consumers through higher gasoline prices, but the corporate sector incurs most of the cost, squeezing their profits. The basic materials industry, such as the steel industry, has passed the higher cost to buyers, but a continuous increase in price will become impossible at some point. Such fears may influence a deterioration in the DIs for Business Conditions in the raw materials industry. A balance shift between positive and negative factors regarding corporate profits will continue. In addition, as the effect of those factors differs by industry, the gap among industries or companies may widen. Any change in exchange rates will also affect corporate profits. Large manufacturers expect 1.18 yen per dollar on average for fiscal year 2, and 14.9 yen per dollar, a slight appreciation of the yen, for the latter half of FY2, according to the September Tankan survey. But actual exchange rates move between 11 and 11 yen per dollar, and expected exchange rates are significantly stronger than the actual level. As a result, some pointed out an effect from weaker-than-expected yen rates. Since expected yen rates are much stronger than the actual level, profits of the exporting industries could surpass initially any expected level. But weaker-than-expected yen rates will result in higher-than-expected costs of raw materials. A close watch on the negative impact of continuous depreciation of the yen is required. (2.1.4) yoy, % 3 Japan: Imports by country and region Asia EU U.S. Others Total Source: Ministry of Finance UFJ Institute Economic Research Dept. Global Watch October 2 2

4 US ECONOMY By Shin Takayama, Economist The U.S. economy remains steady. Real GDP grew by an annualized 3.3% on a quarter-on-quarter basis (qoq) in the second quarter. The growth rate is lower than the previous quarter (an annualized 3.8% qoq), but still in line with the potential growth rate of mid-3%. A reduction in inventory due to adjustments made by car dealers held down the growth rate, but final demand, which consists of consumption, housing investment, business investment, and exports, remained brisk. The Gulf of Mexico suffered serious damage from Hurricanes Katrina and Rita in August and September. As the region accounts for one third of U.S. crude oil production and one half of petroleum production, the domestic energy supply has been badly affected. Oil prices are hovering at 6 dollars per barrel, and it is feared that household consumption will be squeezed. But as the income environment remains favorable at present, the household sector may be able to absorb higher energy costs. In addition, reconstruction will create demand. It is unlikely that the economy will lose momentum abruptly. (2.9.22) Second quarter current account deficits fell to $19.7 billion. The current account deficits fell by $3.1 billion from the previous quarter to $19.7 billion in the second quarter. The deficit in the transfer account decreased due to a cut in the government s foreign aid, holding down current account deficits. Trade deficits in goods and services continued to expand: The surplus in the service account increased by $.33 billion, while the deficit in the good account expanded by $.6 billion. The balance in the income account turned a deficit due to an increase in interest-rate payments for the first time in the last three years. U.S.: Current account $ billion Balance on transfers Balance on income Balance on trade in goods and services Current account Source: U.S. Dept. of Commerce UFJ Institute Economic Research Dept. Global Watch October 2 3

5 As for the financial account, the net inflow of foreign money increased by $ billion from the previous quarter to $393.7 billion. The main factor behind the increase was a rise in foreign loans to U.S. financial institutions. In addition, net inflows for portfolio investment, excluding those for U.S. Treasury securities, increased significantly, while the net foreign sector s purchase of U.S. Treasury securities remained stagnant. Net inflows for direct investment halved, compared with the previous quarter. (2.9.22) U.S.: Financial account $ billion Loans and others Portfolio investment (excl. U.S. Treasury securities) Direct investment 1 U.S. Treasury securities Source: U.S. Dept. of Commerce Net inflow of foreign money EUROPEAN ECONOMY By Shin Takayama, Economist U.K. growth rate fell to 1.% yoy in the second quarter. It has become increasingly obvious that the U.K. economy is slowing. Second quarter growth fell to 1.% yoy. Net exports supported growth, but a reduction in inventory depressed the growth rate. Private consumption, which led the economy until last year, has lost momentum. (2.9.28) U.K.: Real GDP growth rate (yoy, %) Net exports Inventory Fixed investment Government consumption Private consumption Real GDP Source: Datastream UFJ Institute Economic Research Dept. Global Watch October 2 4

6 CHINESE ECONOMY By Mariko Noda, Economist An increase in inventory may be a reason for the rise in metal exports. Experts have pointed out that the recent strength in Chinese exports was the result of an export drive caused by inventory accumulation. The ratio of product inventory to industrial production on a nominal GDP value base rose from the bottom of 1.% in 22 to 16.8% at the end of June 2. The level of inventory accumulation differs by industry. The most notable rises in inventory are seen in the coal mining, ferrous metals mining, smelting of ferrous metals, and smelting of non-ferrous metals industries. Trillion Yuan) China: A rise in the inventory ratio % /1-6 Note: Figure for industrial production value in ' is an annualized figure of the first half of the year. Inventory value is as of the end of June. Inventory ratio = Inventory value / Industrial production value (%) 17. Industrial production 16. (Nominal 16. GDP base value, L-H) 1. Product 1. inventory 14. value (As of end of 14. period, L- H) Inventory ratio (R-H) China: Inventory accumulated in the metal industry yoy, % /1-6 Coal Mining & Dressing Ferrous Metals Mining & Dressing Smelting & Pressing of Ferrous Metals Smelting & Pressing of Non Ferrous Metals UFJ Institute Economic Research Dept. Global Watch October 2

7 In general, the main driving force of Chinese exports is machinery, but the contribution rate of metal products has risen. This development is consistent with inventory accumulation. Nevertheless, there has not been any significant discount in export prices. The export unit value of metals continues to rise on a year-on-year basis. In sum, an accumulation in inventory may be part of the reason for the export drive, but it may be also true that a rise in metal prices in the global market has encouraged Chinese companies to expand exports in order to maximize profits. (2.1.) China: Growing contribution of metals to export growth yoy, % /1-8 Others Mineral products Optical, Photographic, etc Vehicles Chemical products Textile Base metals Machinery Total Chine: Export unit values are rising yoy, %) /1 /2 /3 /4 / /6 /7 Export unit value average Mineral product Textile product Base metals product Machinery UFJ Institute Economic Research Dept. Global Watch October 2 6