Japan Manufacturing Mood up, but Yen Clouds Outlook

Japanese manufacturing confidence improved for a fifth straight month in September, but the pace of recovery slowed to a crawl, with a strong yen and faltering global growth starting to take a toll on the world's No.3 economy, a Reuters poll showed.

Prime Minister Yoshihiko Noda, addressing parliament Thursday, highlighted the threat posed by the buoyant yen to Japan's recovery from the March earthquake and repeated his pledge to work with the central bank to limit the damage.

The monthly Reuters survey, closely correlated with the Bank of Japan's quarterly tankan corporate poll, showed the manufacturing sentiment index rose slightly while the non-manufacturers' gauge fell for the first time in three months.

The poll of 400 big firms, of which 257 responded, also cast doubt on the prospects for further recovery from a recession triggered by the March 11 earthquake and tsunami. The survey's main sentiment gauge is seen rising further by December, but falling short of pre-quake levels.

The next BOJ survey due Oct. 3 is expected to paint a similar picture -- moderate improvement in sentiment and doubts about the future -- keeping the central bank under pressure to ease policy again to prop up the economy and tame the yen.

Noda has repeatedly warned of a threat of hollowing out of the Japanese industry because the yen's strength was eroding exporters' profits and boosting their domestic costs. As finance minister in the Cabinet of his predecessor Naoto Kan, he oversaw three interventions in foreign exchange markets over the past year, the last one a record 4.5 trillion yen-selling operation on Aug 4.

Despite government efforts, the Japanese currency has continued to trade near its all-time highs hit in mid-August, boosted in large part by investors seeking safe havens from global markets which are being roiled by Europe's growing debt crisis and the weak U.S. economy.

As if to underscore Noda's concerns, Elpida Memory Inc <6665.T>, the world's No.3 maker of dynamic random-access memory, said on Thursday it was considering moving some production to Taiwan to cope with the yen's rise.

The anxiety about the future is likely to heighten through jitters in financial markets, said Masamichi Adachi, senior economist at JPMorgan Securities Japan.

That, together with expectations about a prolonged deflation and low economic growth, keeps up pressure on the BOJ to do more.

The Reuters Tankan survey's manufacturing sentiment index, derived by subtracting the percentage of pessimistic responses from optimistic ones, rose just 2 points in September to plus 8, the smallest gain since the index plunged in April after the March disaster.

Confidence weakened in sectors including chemicals, steel and exporters of cars and electronics, according to the survey taken from Aug. 26 to Sept. 12.

The index is seen improving further to plus 13 in December, though still below levels seen just before the magnitude 9.0 earthquake and deadly tsunami devastated the northeast coast and triggered a radiation crisis at the Fukushima Daiichi nuclear plant.

A separate Reuters poll taken alongside the tankan survey showed about two-thirds of manufacturers were hurt by the strong yen and trying to cope with it by shifting operations overseas.

The Reuters survey underlined concerns recently voiced by a BOJ policymaker and Standard & Poor's.

BOJ board member Ryuzo Miyao said the economy may get less support than expected from overseas due to Europe's debt crisis and U.S. slowdown, while S&P cut its economic outlook, blaming in part slow government response to the March disaster.

Companies polled by Reuters said weakening U.S. and European demand were also a source of concern in addition to the yen's strength.

The effects of the earthquake and stagnation in Europe and U.S. economies have cast a shadow over the electronics sector, an electric machinery maker said.

Japan's economy shrank in April-June at a faster pace than initially reported as companies held back on capital expenditure in the face of growing global uncertainty. Analysts polled by Reuters forecast a strong rebound this quarter, largely due to post-quake rebuilding, but trimmed their fourth-quarter growth estimates.

(Additional reporting by Kaori Kaneko; Editing by Tomasz Janowski)