Japan's surprisingly weak industrial output darkens economic outlook

Japan's industrial output unexpectedly fell as factories cut output to key Chinese and European markets while a leading indicator for manufacturing hovered at its lowest in 16 months, in a sign that the economy could contract in the third quarter. Industrial output dropped 1.2 percent in July compared with a median estimate for a 1.7 percent increase in a Reuters poll and followed a 0.4 percent gain in June.
In a further sign of trouble ahead, the purchasing managers index for August showed manufacturing activity contracted for a third straight month as domestic and external demand suffer. Manufacturers said they expect output to rise only modestly in August and then fall again in September, which could increase the chance that the economy will contract in the third quarter and pressure policymakers to bolster growth.
"Exports to China and the European Union have been decreasing, so electronics parts makers are cutting back on production to adjust inventories," said Seiji Adachi, senior economist at Deutsche Securities. "Forecasts for August and September show that output is on a downtrend."
Asia's other major exporters are also feeling the pinch from the global slowdown. South Korea's factory output, which closely tracks exports of smartphones, cars, machinery and ships, fell a larger-than-expected 1.6 percent in July. The yen showed little response to the surprisingly weak industrial output and PMI data. The downbeat data sent the benchmark 10-year JGB futures contract to a two-week high and it stayed near that level in later trade.
"The Bank of Japan has to downgrade quite considerably their economic outlook going forward, given these figures, and I think this will put them in a very tight spot because they've already promised a 1 percent inflation rate," said Shogo Fujita, chief Japan bond strategist at Bank of America Merrill Lynch. Manufacturers surveyed by Japan's trade ministry expect output to rise 0.1 percent in August and then decrease 3.3 percent in September.
The Markit/JMMA Japan Manufacturing Purchasing Managers Index (PMI) fell to a seasonally adjusted 47.7 in August from 47.9 in July, the lowest level since April 2011, one month after the earthquake struck Japan's north-east coast. The core consumer price index, which includes oil products but excludes volatile prices of fresh fruit, vegetables and seafood, fell an annual 0.3 percent in July, separate data showed, matching economists' forecast as deflation persists. The so-called core-core inflation index, which excludes food and energy prices and is similar to the core index used in the United States, fell 0.6 percent in the year to July, it showed.