Tankan Report Shows Japan's Recovery Is Not Yet Strong

The anxiously awaited report of business sentiment prompts the Bank of Japan to buy dollars.
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World financial markets, particularly the foreign-exchange market, have been anxiously awaiting the release of Japan's quarterly survey of business sentiment, known as the


, since first-quarter GDP data on

June 10 indicated the economy has stopped contracting.

The results of the June tankan were largely in line with consensus expectations. While the report suggests Japan's economy is moving in the right direction, it does not indicate a strong recovery. The 1.9% first-quarter growth rate will probably not be sustained, it suggests.

The report's headline component, its large-manufacturers sentiment indicator, improved to minus 37 from minus 47. Large manufacturers also revised their capital investment plans; they now project a 7.9% reduction in the current fiscal year rather than the 9.4% cut anticipated in the March survey. Sentiment among large non-manufacturers and small manufacturers also improved modestly.

Following the report, the

Bank of Japan

underscored its commitment to preventing a premature rise in the yen by once again buying dollars in the currency market. The intervention pushed the dollar further in the direction it was already headed -- a more effective tactic than fighting the market -- extending a short squeeze. The dollar finished last week just below the 121 level against the yen, and the intervention helped push the dollar above the 122 yen level for the first time in a couple of weeks. Japanese exporters and some foreign investors will likely cap the dollar at the 122.30-122.60 yen area.

The initial market reaction to the tankan appeared to be dollar-buying on mild disappointment that the improvement was not as great as the whispers had suggested it would be. Conspiracy theorists have argued that the BOJ's interventions over the past several weeks were aimed at depressing the yen so that it would begin a post-tankan rally from lower levels. Questionable when first floated, the theory looks even more dubious now.

The tankan report does little to shed fresh light on the state of the Japanese economy. Yes, sentiment has improved marginally and the preliminary outlook is for more improvement in the September survey. However, the economy is still a long way away from achieving a self-sustaining expansion. Government spending continues to provide life support for the otherwise moribund economy.

The most recent data showed that Japan's industrial production fell to new five-year lows in May. Net exports were a drag on Japan's growth in Q1 and the data thus far indicate they continue to be a drag on Q2 growth. Deflationary pressures are still evident and bank lending remains constipated. While some data suggest Japanese households have increased their propensity to consume in recent months, income continues to fall. Monetary and fiscal policy will have to remain accommodative for the foreseeable future.

Meanwhile, the Japanese stock market is flirting with the 18,000 level. Foreigners continue to provide the bids. They have been net buyers of Japanese equities for 22 of the past 23 weeks through June 25.

The demand for Japanese equities is not necessarily the same as the demand for yen. In recent months, it appears foreigners have sold more Japanese government bonds than equities purchased. In addition, some of foreign investors in Japanese equities hedge their currency risk by selling yen.

The foreign buying does help provide a cushion for Japan as it restructures. In particular, a recent report suggested that Japanese businesses have stepped up the pace of liquidating cross-shareholding investments. The report suggested that almost 2.8 trillion yen of cross-shareholding was sold in the past 6 months, compared to 3.1 yen trillion all of last year. It appears foreigners are stepping in to fill the vacuum, as they have in the past in other countries, including the U.S.

Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at