Japan's shaky business mood, GDP downgrade cloud BOJ hike timing

By Leika Kihara

TOKYO (Reuters) -The business mood in Japan's service-sector soured in June as the lower yen pushed costs higher, a quarterly central bank survey showed on Monday, offsetting a big lift in factory confidence and pointing to consumption weakness.

A rare unscheduled downgrade to Japan's historical gross domestic product (GDP) data also showed the economy shrank more than reported in the first quarter, which will likely force the Bank of Japan (BOJ) to cut its growth forecasts later this month.

The findings, which come ahead of the BOJ's next policy meeting on July 30-31, complicates its decision on how soon to raise interest rates, analysts say.

"The improvement in business sentiment may have peaked particularly for non-manufacturers. This data doesn't necessarily help the BOJ make the case for an early rate hike," said Toru Suehiro, chief economist at Daiwa Securities.

"But corporate inflation expectations heightened slightly, which will likely keep alive market expectations for a near-term rate hike," he said.

The BOJ's closely watched "tankan" survey showed on Monday the headline sentiment index for big manufacturers hit +13 in June, up from +11 in March and slightly exceeding a median market forecast for a reading of +12.

The reading, which was the highest since March 2022, reflected a rebound in auto output and success by manufacturers to pass on rising raw material costs through price hikes.

But service-sector firms were less optimistic than three months ago, the survey showed, as rising labour costs from a tight job market added to the pain from stubbornly high imported raw material prices, the survey showed.

An index measuring big non-manufacturers' sentiment fell to +33 in June from +34 in March, matching market forecasts and worsening for the first time in two years.

While big manufacturers expect conditions to improve three months ahead, their service-sector counterparts project conditions to worsen further as rising costs squeeze margins.

An index measuring output prices rose for both manufacturers and non-manufacturers, the survey showed, a sign inflationary pressures continued to build.

Long-term corporate inflation expectations rose slightly with companies projecting inflation to hit 2.3% three years from now and 2.2% five years ahead, the tankan showed.

REVISION MAY AFFECT BOJ MOVE

Separately, a revision to historical data showed on Monday Japan's real GDP shrank an annualised 2.9% in January-March, down from an earlier estimate of a 1.8% contraction.

The GDP for the third and fourth quarters of last year were also revised down. The government said the downgrade reflected corrections made in past construction orders data.

The revisions, which came on top of recent weak consumption and output data, are likely to affect the BOJ's quarterly growth and price forecasts due at its July 30-31 policy meeting.

Yoshiki Shinke, an economist at Dai-ichi Life Research Institute, expects the GDP revisions to lead to a significant downgrade in this fiscal year's economic growth forecast.

"I wonder if the BOJ can manage to trim bond buying and hike rates simultaneously in July, when there's a growth downgrade showing the economy was in worse shape than thought," he said.

The BOJ ended negative interest rates in March as it judged that sustained achievement of its 2% inflation target has come into sight. Many market players expect the BOJ to raise rates again this year, but remain divided on how soon it will come.

BOJ Governor Kazuo Ueda has said the central bank will raise rates further if there is enough evidence that underlying inflation will durably meet its 2% target, as it projects.

(Reporting by Leika Kihara; Additional reporting by Yoshifumi Takemoto; Editing by Sam Holmes)