Big Japanese manufacturers turned optimistic for the first time in two years in the April-June quarter and forecast a rise in capital spending plans in a sign that a slow economic recovery is taking hold. The Bank of Japan tankan of more than 11,000 companies also showed optimism among big manufacturers would grow further in the current quarter, although analysts said the report may not have accounted fully for a sharp drop in Japanese stocks between April and June and a rally in the yen to a two-month high against the dollar. The yen is higher than the level big manufacturers, the main drivers of Japan's exports, have forecast for the current fiscal year to next March and companies hardly see the need to increase hiring, the report showed, suggesting headwinds to the recovery from the global downturn that would require the central bank to keep monetary policy loose. Most other manufacturers and service-sector firms reported an improvement in sentiment but were still pessimistic. "Overall, the tankan survey shows better corporate sentiment, especially among big manufacturers, who have raised their outlook, but it still leaves some elements of concern," said Ayako Sera, a market strategist at Sumitomo Trust and Banking in Tokyo. "The survey does not paint an entirely optimistic view for the economy." The headline index measuring big manufacturers' sentiment improved 15 points to plus 1 in the three months to June, nudging above the zero threshold that divides optimism from pessimism. A Reuters poll had forecast an outcome of minus 4. Graphic on sentiment index, click http://link.reuters.com/zan25m These firms, including industries such as automobiles, machinery, construction and retail, have been pessimistic since the third quarter of 2008 when the world economy was hurtling towards a recession precipitated by the collapse of Lehman Brothers. The big manufacturers' index is seen rising to plus 3 in the third quarter, which would mark the sixth straight quarter it has shown an improvement. Encouraged by solid exports to Asia, big firms forecast a 4.4 percent rise in capital spending this financial year, following two years of spending cuts. YEN WORRY Big firms made up about a fifth of the survey, but attract most interest because they drive the country's exports. The report was largely ignored by financial markets, which focused more on concerns about a fresh setback for the global recovery following data pointing to a slowdown in China. Yields on Japanese government bonds fell to a seven-year low and the Nikkei average dropped to a seven-month low. That followed a 15 percent decline in the second quarter. Japan's economy expanded faster than Europe and the United States in the first quarter, lifted by strong exports. However, deflation and ample spare production capacity are limiting the scope for a pickup in growth. Indeed, recent trade and industrial output data have pointed to a moderation in Japan's economic growth through the middle of the year. "Uncertainty over the outlook, stock falls, the yen's further gains as well as a rise in real interest rates due to deflation may hit corporate capital spending ahead," said Junko Nishioka, chief Japan economist at RBS Securities. That adds to the challenges for Prime Minister Naoto Kan as he leads his ruling party into a July 11 upper house election with pledges he can strengthen the economy and repair the country's tattered finances with tax hikes. The yen was trading at 88.35 per dollar, above the 90.18 that big manufacturers expect to be the average level this fiscal year. They raised their forecast from 91.00 yen three month ago. Some analysts say a central bank lending programme introduced in December was partly designed to push the yen lower to help exporters. The further the yen rises, the more pressure the government may put on the central bank for more policy action. The tankan will be scrutinised at the next central bank rate review on July 14-15. The central bank will likely keep rates near zero and review its long-term forecasts for the economy to recover on strong Asian growth. "The economy is moving in the direction that the BOJ and the government are describing, but there is still a long way to go until we get a self-sustained recovery," said Naomi Hasegawa, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.

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