TOKYO, July 1 - Japan's large companies felt unexpectedly more optimistic about business prospects in the past three months, data showed on Tuesday, raising hopes the world's second-largest economy may finally be heading for recovery. But in a sign that any rebound may not be a strong one just yet, sentiment remained flat for the July-September quarter and smaller companies were downbeat as they battled falling prices and slow domestic demand. The Bank of Japan's quarterly "tankan" corporate survey for April-June showed that sentiment at large manufacturers, measured as a diffusion index, improved to minus five in June from minus 10 in March. It was the strongest reading in more than two years and much better than the median forecast of minus 10 in a poll of 23 analysts, helping the Tokyo stock market's key Nikkei average <.N225> rise over two percent and pushing the yen up slightly against the dollar. "Although there has been a feeling that the economy was losing momentum, the tankan gives us the impression that it may actually be improving," said Soichi Okuda, a senior economist at Aozora Bank. "The end of the Iraq war and a global stock market rally seem to be strongly reflected in the figures."
The tankan diffusion index measures sentiment by subtracting the percentage of companies reporting unfavourable conditions from the number that say they are favourable. The survey was conducted as the Iraq war wound down and the effects of Asia's SARS virus outbreak were fading. It also coincided with a 14 percent rise in the Nikkei average in the quarter, spurred by gains in other world markets. Signs that the U.S. and other major world economies may pick up later this year are also helping large companies, which are more dependent on exports, in particular the fast-growing China market and the United States, Japan's largest single market. They expect a rise in capital spending of 4.9 percent in the business year that began in April, the strongest in 13 years, the tankan showed, compared with a poll forecast of 0.2 percent. "This is a much better result than expected, and it looks as if a long-awaited recovery in capital spending is on the cards," said Norihiro Fujito, a strategist at Mitsubishi Securities. MANUFACTURING EXPANDING Adding to evidence of an upturn, a separate survey released on Tuesday found that Japan's manufacturing activity expanded to a 10-month high in June. The overall index in the /Nomura/JMMA Purchasing Managers survey rose to 50.4, climbing above the boom-or-bust threshold for the first time in two months. It is only the seventh time the index has topped 50 since the survey began in October 2001, and suggests an expansion in manufacturing activity.
Large manufacturers also see profits rising 11.6 percent this business year, according to the tankan, though sales will likely fall 1.0 percent, showing that cost cutting and restructuring remain the main drivers of corporate health. Some of the cost-cutting at large companies may be coming at the expense of the thousands of smaller companies across Japan that supply them with everything from screws to high-tech devices. Rationalisation at big firms means less orders for small ones, which in turn have less room to cut their own costs and which face difficulties in getting financing from risk-averse banks. The tankan reflected these concerns, showing smaller manufacturers only slightly more optimistic, with a rise to minus 28 from minus 29, the first improvement in six quarters. "I still see a gap between big and small firms and it shows that regional economies and smaller firms are still suffering," said Kosuke Hanao, head of foreign exchange at the Royal Bank of Scotland. At the same time, economists noted that both large and small manufacturers are forecasting sentiment will be unchanged in the July-September quarter, indicating they are cautious on the outlook. That caution is shared by the government. "It's not much of an improvement. We of course still need to keep an eye out on conditions as we conduct economic policy," Chief Cabinet Secretary Yasuo Fukuda told a news conference. Both the government and central bank have downgraded their views on the economy, saying exports and capital spending were no longer providing the support they had earlier in the year. "Current sentiment has benefited a lot from benign overseas conditions," said Seiji Shiraishi, chief economist at Daiwa SMBC Securities. "But we can't be bullish about the improvement spreading."//