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July 18th, 2012

After the BoJ passed up the opportunity to further ease monetary policy in July, dealers are looking for new signs of worsening data to give the BoJ unassailable reason to loosen policy at their August 8-9 meeting. Thursday brings a fair chunk of data on Japan’s economy, including the Bank of Japan’s Q2’12 Bank Loan Officer Survey, the May all-sector activity index and June nationwide department store sales. But the freshest statistics are also out the earliest: the Reuters Tankan* survey of manufacturing and non-manufacturing posts at 08:30 Tokyo time on July 19.

The Reuters Tankan is a monthly survey of leading Japanese companies covering a panel of 200 manufacturers and 200 non-manufacturers. The monthly figures are designed to provide early indications of the BOJ’s quarterly tankan. The diffusion indices are derived by subtracting the percentage of respondents who say business conditions are poor from the percentage of those who say they are good. A positive reading means optimists outnumber pessimists. The monthly poll is highly correlated with the Bank of Japan’s quarterly tankan survey, a key economic indicator for markets in Japan and the rest of the world.

In broad terms, economists from J.P. Morgan Securities commented, “This survey, the earliest business survey for July, will provide a clearer indication of the economy’s current momentum, as well as the outlook, after monthly June business surveys were generally soft.” Anticipating both the magnitude and direction of the change, Daiwa Capital Markets remarked, “The survey is likely to show a slight deterioration in business conditions at the start of Q3. The latest domestic machine orders figures were shockingly weak.”

Each month’s survey includes a forecast of sentiment three months ahead. In the April survey, for example, manufacturers had pegged July sentiment to increase to +6, while non-manufacturers saw future sentiment rising to +16. As concerns about Europe’s debt crisis, a strong yen and a slowdown in the Chinese economy failed to abate, however, the mood among firms should fail to meet respondents’ prior predictions for July. This is also evident in the evolution of future sentiment readings among manufacturers from the latest two surveys, where the forecast of +8 for August dipped to +4 for September. The 3-months-ahead forecast has not been negative since the February 2012 survey but could be so in the July survey.

Last week, Japan’s Cabinet Office reported that its Economy Watchers’ Survey index had dropped in June for the third month in a row, this time to the lowest level (42.1) since May 2011; the forward-looking index fell for a second straight month. Those results were sufficient for the government to downgrade its growth assessment, saying that Japan’s economy is “now showing some weakness.” A month earlier, the government’s description was that, “the pace of the recovery has moderated.” But the business sub-index (44.4) fell less (and remained at a higher level) than the household sub-index (42.1), suggesting the mood among firms is higher than the mood among the self-employed. The higher business sub-index could also partly rationalize the BoJ’s determination to leave policy unchanged at its July 11-12 Policy Board meeting.

After overlaying Japan GDP (y/y AR) to the BoJ Tankan diffusion index for large manufacturers, the research department at Intesa Sanpaolo believes, “Probably the best is behind us.” On what that may mean for BoJ policy, Intesa wrote in their latest monthly publication Macroeconomic Outlook, “The positive impact of BoJ interventions has been weakened by the spread of the crisis in Europe. This suggests that, even with huge increases in liquidity, the exchange rate will struggle to weaken, thereby limiting the expansionary effects of monetary policy.”

The Global Economics Team at Bank of America Merrill Lynch believes the BoJ has “potential opportunities to strengthen its policy of monetary easing” at either or both of the next two Policy Board meetings 8-9 August and 18-19 September. In their latest Global Economic Weekly, BoAML economists wrote, “We believe the most likely option would be an extension of the treasury bond purchase scheme by ¥5-10 tn.”

The Large Manufacturing component of the BoJ Tankan report is a data input in the HSBC Global Markets economic surprise index for Japan. Their index got a modest lift last week from better-than-expected results on the Tertiary Industry Index, but HSBC’s currency strategy team warned Wednesday that, “The Japan activity surprise index is showing no clear direction.” Changes in the monthly indexes measuring sentiment among materials and manufactured products corporations, however, could affect the index as it skirts a multi-year bottom. Deutsche Bank Global Markets Research also includes Tankan data (for both manufacturers and non-manufacturers) in its DB Macro Pulse Index (MPI), where the dealer expresses surprise as a z-score. Given the high correlation between the monthly series and the quarterly official data, there may be some surprises for markets and the BoJ in the July Reuters Tankan survey.

Weaker incoming data regarding machinery orders and industrial production likely undermined confidence among Japan’s manufacturing firms into early summer. Monthly sentiment levels among non-manufacturers have remained steady at positive levels, but 90-day forecasts have already begun to roll over. Accordingly, inasmuch as sentiment readings in the monthly report align to readings in the quarterly BoJ report, dealers will be looking for the July Reuters Tankan for concrete signs that the BoJ should take the opportunity to ease policy at its next one or perhaps two meetings.

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