Japan's reconstruction-fueled rebound waned in the secondquarter as consumer spending growth almost stalled and export gainsdiminished, increasing the chance for monetary and fiscalstimulus.

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Gross domestic product advanced an annualized 1.4 percent in thethree months through June, less than the median estimate of 2.3percent in a Bloomberg News survey of economists and down from 5.5percent the previous quarter, a Cabinet Office report showed inTokyo today. Unadjusted for prices, GDP contracted at a 0.6 percentannual pace.

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Consumption rose the least since households cut spending in theimmediate aftermath of the March 2011 earthquake, signaling afading boost from government incentives that have supporteddomestic demand. With yen strength and Europe's crisis curbingexports, today's report escalates pressure on policy makers to headoff a deeper slowdown in the world's third-largest economy.

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“Drafting a supplementary budget is already a done deal, as theJapanese economy can anticipate little support from overseas demandand the government has no other choice but to mobilize fiscalspending,” said Hiroshi Watanabe, a senior economist at SMBC NikkoSecurities Inc. in Tokyo. “Political pressure on the Bank of Japanwill probably intensify as deflation is expected to remainentrenched, just as today's GDP deflator indicates.”

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The GDP deflator, a measure of price trends across the economy,contracted 1.1 percent from the same quarter a year earlier,today's report showed.

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The yen traded at 78.24 as of 4:44 p.m. in Tokyo and the Nikkei225 Stock Average fell 0.1 percent. Volume on the index was almost41 percent below the 30-day average because of the O- bon holiday,a festival starting today during which many Japanese companiesclose for as long as a week.

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From the previous quarter, GDP grew 0.3 percent. Quarter-on-quarter figures show consumer spending rose 0.1 percent in theApril to June period, slower than a 1.2 percent advance in theprevious three months. Net exports, or exports less imports, cut0.1 percentage point from GDP.

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Government Subsidies

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Government incentives for households to purchase fuel- efficientcars have been supporting consumer spending, which accounts formore than half of the economy. Mizuho Securities Co. expects theprogram to expire this month, which may increase the nation'sreliance on overseas demand for growth. Prime Minister YoshihikoNoda has also budgeted 19 trillion yen ($243 billion) forrebuilding from last year's earthquake and tsunami.

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The government is planning to compile a supplementary budgetthis autumn after reviewing today's GDP report, Kyodo News said,without citing where it obtained the information.

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Economists at Itochu Corp. and Mizuho Securities Research andConsulting Co. said the economy may contract in the fourth quarteras subsidies fade. BNP Paribas cut its GDP forecasts for the restof the year, predicting an annualized 0.9 percent contraction inthe July-September period and 0.1 percent growth in the final threemonths of 2012.

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Today's report indicated that household spending would have beenweaker without the government incentives. Consumption of durablegoods rose 3.1 percent in the second quarter, while semi-durablegoods and non-durable goods fell and services increased 0.2percent, the least since the first quarter of 2011, today's reportshowed.

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“Car sales supported gains in durable goods in the secondquarter, but overall consumption was dull,” said Norio Miyagawa, asenior economist at Mizuho Securities Research in Tokyo. “Consumerspending may decline in the fourth quarter as the boosts from thegovernment's incentives will peter out by then.”

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With the sales-tax increase passing the Diet last week, pressuremay rise on policy makers to consider a supplementary budget andmonetary stimulus to shore up domestic demand. Finance Minister JunAzumi said last month the government would weigh whether morespending is necessary after examining today's report.

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In Europe later today, reports may show retail sales rose 2.5percent in the Netherlands in June from a year earlier andincreased 4.1 percent in Norway, according to surveys of economistsby Bloomberg News. A report tomorrow will probably show the economyof the Euro zone shrank in the second quarter.

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Slovakia's consumer price index may have advanced 3.6 percent inJuly from a year earlier, the same pace as the previous month, asurvey showed.

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In Mexico, a report may show industrial production gained 3.4percent in June from a year earlier and 1 percent from the previousmonth, a separate survey of economists showed.

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Rising Yen

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The yen's advance against the dollar is also eroding the valueof overseas earnings, with exporters such as Sony Corp. and CanonInc. cutting profit forecasts in the past month.

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Sony cut its full-year profit forecast on Aug. 2 after gains inthe yen eroded overseas earnings and sales of consumer electronicsweakened. Canon, the world's largest camera maker, also last monthcut its full-year profit forecast because of a stronger yen andexpectations for weaker growth in the U.S., Europe and China. Sonyand Canon get about 70 percent and 80 percent of sales revenueoutside Japan, respectively.

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The Bank of Japan refrained from easing policy at a boardmeeting last week. Central banks around the world have beensupporting their economies as Europe's woes deepen. The Philippinesunexpectedly cut interest rates a third time this year to a recordlow on July 26, and the U.S. Federal Reserve said on Aug. 1 that itwill pump fresh stimulus if necessary.

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“The government and the BOJ can do something to mitigate thepressure on the economy, but I don't think fiscal policy is reallyworking apart from reconstruction spending,” said HiromichiShirakawa, chief Japan economist at Credit Suisse Group AG and aformer central bank official. “There is more pressure on the Bankof Japan than the government to do something.”

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Bloomberg News

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