REPEAT: MNI ANALYSIS: Japan Econ Makes Solid But Slow Q3 Start

--Repeating Story Published at 1829 JST (0929 GMT/0529 ET)

By Max Sato

     TOKYO (MNI) - Japan's economy started the July-September with a softer tone

after strong growth far above its potential in the previous quarter, staying on

a modest recovery track but facing uncertainty.

     Industrial production posted the first month-on-month drop in two months in

July, falling a seasonally adjusted 0.8% in what the government called a

"relatively small reaction" to the strong 2.2% rise in June, data released

Thursday showed.

     The government maintained its assessment that factory output "shows signs

of a pickup," noting it rose 4.7% on year, the ninth straight year-on-year

increase, and the level of the Index of Industrial Production stood at 101.5 in

July, above the 101.0 average in the first six months of the year.

     Real average household spending posted the first year-on-year drop in two

months, down 0.2% in July after a sharp 2.3% rise in June, but the government

maintained its view that spending is on a recovery trend, data released Tuesday

showed. The three-month moving average of May-July spending rose 0.7%, the

second straight rise after a gain of 0.2% in April-June, reflecting a gradual

increase in income.

     The core spending index, which excludes housing, motor vehicles and other

volatile items (close to private consumption patterns in GDP data) fell 0.3% on

month in July on a seasonally adjusted basis, the first month-on-month drop in

two months following +0.8% in June.

     "We had a slightly weaker start in the July-September quarter," said

Akiyoshi Takumori, chief economist at Sumitomo Mitsui Asset Management.

     "There are downside risks from weather patterns and it is uncertain how the

North Korean missile scare will affect tourism in Hokkaido," he said, referring

to the northern Japanese region over which Pyongyang, without warning, on

Tuesday launched a medium-range ballistic missile into the Pacific Ocean east of

Hokkaido.

     Based on its survey of factory operators, the Ministry of Economy, Trade

and Industry forecast that production would rise 6.0% on month in August before

falling 3.1% in September. Based on this projection, production in the

July-September quarter is estimated to rise 2.4% on quarter, which would be the

sixth straight quarterly increase after +2.1% in April-June.

     However, adjusting the upward bias in output plans, the METI projected

production would rise only 1.4% on month in August. On this assumption, the

level of production in September is likely to be flat or slightly lower than in

August, the METI said.

     This year, industrial production has been showing ups and downs on the

month, falling in the odd-number months (-2.1% in January, -1.9% in March, -3.6%

in May and -0.8% in July) while rising in the even-number months (+3.2% in

February, +4.0% in April and +2.2% in June).

     "This means the distortion in seasonal adjustments caused by the 2011

earthquake that hit northeastern Japan has not been smoothed out and it will

remain in the production statistics at least until the end of the year,"

Takumori said. "For now we also have to look at year-on-year changes to see the

trend."

     Mizuho Research Institute senior economist Hidenobu Tokuda said the economy

is likely to show that a modest recovery is continuing into the July-September

quarter, but at a slower pace than in the second quarter.

     Japan's economy for the April-June quarter posted high growth of 1.0% on

quarter, or an annualized 4.0%, as strong domestic demand -- led by consumption,

business investment and public investment -- offset what is seen as a temporary

slip in external demand.

     "Exports took a breather in April-June and are still doing so. For the

July-September period, growth will be led by domestic demand," Tokuda said.

     But Akihiko Suzuki, chief economist at Mitsubishi UFJ Research and

Consulting, is more cautious.

     "I disagree with the government's assessment that both exports and

production are picking up. I would say exports are peaking and production level

may decline from here," he said. "As for domestic demand, there is no particular

driver at this point."

     Suzuki said the government may be underestimating the risk of orders for

smartphone parts being scaled back should sales of the new iPhone model to be

released later this year turn out to be weaker than expected, as seen two years

ago.

     Cabinet Office officials have said telecommunications equipment exports are

likely to pick up toward the end of the year as demand for iPhone parts

increases, supporting Japanese exports to Asia.

     "Semiconductors are being used widely, not only in iPhones but also in

servers for big data and automobiles," Hideyuki Ibaragi, director of

macro-economic analysis at the Cabinet Office, told MNI. "We hear from the

semiconductor industry that business is booming like they've never seen before."

     Export volumes fell 0.4% on month in July, the second straight

month-on-month drop, after declining 0.6% in June, according to Cabinet Office

data. But Ibaragi noted that export volumes to Asia rose 0.7% in July, showing

that demand is picking up after a temporary dip.

     Retail sales rose 1.9% on year in July for the ninth straight year-on-year

rise, backed by strong demand for air conditioners amid high temperatures and

humidity during the month, METI data released Wednesday showed.

     Compared with the previous month, retail sales rose 1.1% in July on a

seasonally adjusted basis, the second consecutive rise and accelerating from the

gain of 0.2% in June. The three-month moving average of May-July sales fell 0.1%

after being flat in the April-June period.

     The Economy Watchers sentiment index for Japan's current economic climate

posted the first month-on-month drop in four months, down 0.3 point at 49.7 in

July on a seasonally adjusted basis after rising sharply by 1.4 points in June,

but the level remained relatively high in the current recovery phase.

     The slight drop in sentiment reflects the adverse effects of chronic labor

shortages and weather factors. Heavy rainfalls and flooding in southern Japan in

early July caused casualties and long-lasting damage while heat waves made

consumers wary of buying fresh food for fear of food poisoning. On the other

hand, high temperatures boosted demand for air conditioners.

     Erratic weather patterns are likely to affect confidence, Cabinet Office

director of regional economies Masahiko Tsutsumi, who oversees the compilation

of the monthly Economy Watchers' Survey, told MNI.

     "In August, a long stretch of rainy days might have pushed down retail

sales and spending on leisure. There were high expectations that heat waves

would boost sales of air conditioners, but sentiment among consumer electronics

retail stores rose in May, fell in June and rose again in July," Tsutsumi said.

"After high sales in July, we may see slower demand in August."

     The results of the August Watchers' Survey are due on Sept. 8.

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com