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Pricey Oil One More Burden for Struggling Economy

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Japanese/U.S. Visitor Arrival TrendsExternal Conditions

Conditions in key external markets continue to be very weak. Although the U.S. economy managed to avoid a contraction in the first quarter, systemic problems in the housing and credit markets have not abated. The recent surge in oil prices is an added burden for consumers who are already hard-pressed from the housing bust, job losses and weaker income growth. As a result, measures of consumer sentiment have plunged in recent months, leading us to expect a decline in spending in coming months.

Over the past nine months, the price of oil has surged upward, to the $130 per barrel range and beyond, and gas has risen to above $4.00 per gallon. This is having at least two important negative effects: first, eating away the meager gains that have occurred in household income, and second, creating severe cost pressures on energy-intensive industries, particularly the airlines. While we believe that prices in this range are unsustainable, as long as they stay this high there will be increasing damage to the U.S. economy.

High oil prices are also contributing to higher inflation and to inflationary expectations. Uncertainty about inflation contributes to spending restraint. Perhaps more importantly, concerns about inflation will restrain the Fed’s hand in providing monetary stimulus.

The brightest spot in an otherwise dreary U.S. economic picture is exports, which have benefitted from the weaker dollar. Another source of relatively good news has been the labor market, where job losses have been mild compared to a typical recession. The news that unemployment surged to 5.5 percent in May was a worrisome development.

After a flat first half, we expect a modest U.S. recovery to begin by year’s end. For this year as a whole, we expect U.S. real GDP to expand by 1.1 percent, down from 2.2 percent in 2007. Growth will be only 2.4 percent in 2009, with further strengthening as the year progresses.

Japan’s economy began the year on a high note, but recent indicators are much less encouraging. Real gross domestic product expanded at a 3.3 percent rate in the first quarter, according to the first preliminary estimate, the strongest growth since the first quarter of last year. Residential investment, which in Japan has languished like much of the rest of the world, turned up strongly in the first quarter, while business investment was weak.

Exports were particularly strong in the first quarter, but this will not continue. Weak global demand and a 15 percent appreciation of the yen/dollar rate are beginning to slow exports.

Consumer spending growth was strong in the first quarter, but growth has turned negative recently. Japan’s labor market remains relatively healthy, although small net job losses have begun in recent months. The seasonally adjusted unemployment rate remains at a healthy 4 percent.

Forward-looking indicators for Japan are not very encouraging. The Tankan survey of business conditions softened between the December and March reports. And consumer confidence has fallen sharply over the past six months, to levels last seen in early 2003.

Overall, we continue to expect a somewhat better performance for the Japanese economy than for the United States, but with noticeable slowing compared with recent years. Real GDP growth will be 1.4 percent this year, down from 2 percent in 2007. Slightly stronger growth is expected in 2009.

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