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By Hiroshi Inoue
     TOKYO (MNI) - Japan's economy contracted in the January-March quarter but
Bank of Japan officials believe it was a temporary blip and expect the economy
to return to a moderate recovery path in the second quarter, MNI understands.
     The gross domestic product (GDP) fell a real 0.2% on quarter, or an
annualized 0.6% in Q1, posting the first contraction in nine quarters, since Q4
of 2015, when it shrank 0.3% on quarter, or 1.2% on an annualized basis.
     The Q1 GDP came in slightly weaker than the median economist forecast for
flat growth, but it was no surprise to BOJ officials, who had expected the
economy to have slowed in the first quarter, judging from weak industrial
production during the period (-1.4% on quarter) and private consumption (-0.4%).
     BOJ officials believe the economy to return to a moderate recovery track in
the April-June quarter, backed by solid domestic and overseas demand. They see
no need to change their assessment that both production and private consumption
are "on a moderate increasing trend."
     --UNDERLYING SPENDING TREND
     Private consumption, which accounts for about 60% of GDP, was flat with a
slight negative bias (-0.0%) on quarter in Q1 after a downwardly revised +0.2%
(+0.5 in the previous estimate) in Q4. The median forecast was unchanged on
quarter, ranging from -0.2% to +0.2%.
     The severe winter weather and high fresh food prices dampened consumption
in Q1. It was also in payback for firm demand for the iPhone X in the previous
quarter.
     BOJ officials are focused on the underlying trend of consumer spending,
which they believe is supported by improving employment and income conditions.
     In fact, the GDP data showed total compensation of employees comprising
gross salaries and benefits rose a real 0.7% on quarter in Q1 after falling 0.2%
in Q4. It continued to post year-on-year gains for three years, up 2.0% in real
terms, and marked the highest increase in over two decades in nominal terms, up
3.2%.
     --HIGH ENERGY COST
     Looking ahead, BOJ officials are paying attention to the negative impact of
rising crude oil prices on the sentiment among firms and households and their
investment and spending plans.
     High crude oil price will increase import costs for smaller companies that
have been hit by rising materials and labor costs. Those firms find it hard to
transfer high costs to retail prices amid sluggish private consumption.
     The price of Dubai crude oil has traded above $70 a barrel, the highest
since November 2014.
     The rise in crude oil prices is immediately reflected in domestic retail
gasoline prices and affect electricity bills with a few months lag and city gas
bills with about seven months lag.
     --EXPORTS SEEN UP
     In other areas of the economy, the BOJ board expects exports to continue
rising based on firm global growth, although the pace of increase in exports
slowed in Q1. Demand for Japanese capital goods remains solid, reflecting
increasing business investment in other countries.
     The GDP data showed that business investment unexpectedly fell 0.1% on
quarter in Q1 (the median forecast was +0.5%), the first q/q drop in six
quarters after rising 0.6% in Q4. But government and central bank officials
believe domestic demand for investing in equipment remains solid amid labor
shortages.
     BOJ officials are focused on how capital investment plans are revised in
the June Tankan business survey due out on July 2.
--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com
--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com
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