The Japanese Economy is Starting to Make a Comeback After Tsunami

Japan’s (NYSE:EWJ) economy contracted less than expected during its second quarter as the country was quick to reconstruct after the March 11 earthquake and tsunami. Gross domestic product declined at an annualized rate of 1.3% in the quarter ending June 30. Economists had forecast a 2.5% decline.

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In the second quarter, capital investment increased 0.2%, compared to a decline of 1.4% in the first quarter. Public investment rose 3%, its first advance in six quarters, as the result of government rebuilding efforts.

However, yen (NYSE:FXY) gains could hurt exports and the country’s recovery. “The strengthening yen will start to weigh on exports and capital spending,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management in Tokyo. Miyazaki still expects positive growth in the third quarter, “but the yen may damp that momentum.”

The yen (NYSE:FXY), trading above 110 yen per dollar (NYSE:UUP) just a few years ago, is now at 76.89 per dollar, and has gained 5% against the dollar just in the last three months. Former top currency official Eisuke Sakakibara says the yen could rise to a postwar record, and could appreciate beyond 75, as Sakakibara expects “the U.S. economy to be fairly weak for a long period of time.” The dollar-yen rate has already declined by 15 yen over the past year.

Toyota (NYSE:TM) hopes to be back to normal levels of output by September, and will be hiring up to 4,000 temporary workers to help that effort, but the automaker’s business in the U.S. is being hurt by a poor exchange rate. In the last year, the profit on a $20,000 car has declined by 300,000 yen, or $3,900. In Toyota’s first quarter, most of which had passed by the time of the earthquake, the company’s profit declined by 50 billion yen, today the equivalent of roughly $653.2 million.

“The exchange rate is at a level that has an extremely damaging effect on the Japanese economy,” says Osamu Masuko, president of Mitsubishi Motors (NYSE:MTU). When the yen is strong, it makes its products less competitive abroad, and the exchange rate hurts Japanese profits. However, the yen might not be the only factor effecting GDP declines in Japan. France’s GDP fell flat in the second quarter while the economies of both Hong Kong and Singapore also declined.

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Consumer spending fell 0.1% in the April-June period compared to the previous three months, while it fell 0.6% in the first quarter. Net exports (exports minus imports) reduced GDP by 0.8% in the second quarter. The Japanese government has downgraded its growth forecasts for Japan (NYSE:EWJ), expecting a more modest 0.5% growth in GDP for the year that started in April, rather than earlier predictions of a 1.5% expansion.

Despite the last quarter’s declines, industrial production has been increasing for three months, companies are predicting a boost in output, and merchant sentiment is up, all pointing to an economic rebound. “The monthly data show that supply constraints are gradually easing and sentiment has bottomed out as well,” says Economic and Fiscal Policy Minister Kaoru Yosano. “With the steady recovery of supply chains and a certain increase in reconstruction demand, we expect considerably high growth in the second half of this year.”