Japanese companies have become far less gloomy about economic conditions than three months ago, a Reuters corporate survey showed, pointing to a big improvement in the Bank of Japan's closely watched Tankan survey next month.
But grinding deflation will mean Japan 's economic recovery remains modest and the government will keep pressuring the Bank of Japan to ease monetary policy further, analysts say.
Worries about the fragile economy prompted some ruling party lawmakers to call for more fiscal stimulus amid sliding support for the new Democratic Party-led government ahead of upper house elections this summer.
Japanese government bond futures hit a two-month low after the Nikkei business daily reported that banking minister Shizuka Kamei called for an extra budget worth 7 trillion yen ($77.5 billion) for the fiscal year from April to fund steps including public works projects.
The upbeat Reuters survey of corporate sentiment also weighed on JGBs a day after the central bank eased monetary policy in a split vote that suggested it could be unlikely to continue easing in coming months.
Still, deputy Finance Minister Yoshihiko Noda said that while the government needs to act "flexibly and appropriately" to support the economy, it was not considering another stimulus package now.
Manufacturers were at their least pessimistic since June 2008 and predicted that the index of their sentiment could rise to near positive territory in June, thanks to solid exports to Asia , the Reuters Tankan showed.
"This means the Bank of Japan's Tankan survey will show a marked improvement as well," said Yonosuke Iwata, an economist at Dai-ichi Life Research Institute. The Reuters Tankan has a 95 percent correlation with the Bank of Japan's Tankan.
"Still, the overall economic recovery remains fragile because non-manufacturers such as retailers are facing weak domestic demand and deflation, while the effect of government stimulus is expected to fade in the near future."
The manufacturers' sentiment index in the Reuters Tankan rose 19 points from December to minus 8, its highest level since June 2008. The index is expected to rise a further seven points to minus 1 in June.
Service-sector firms were at their least pessimistic since November 2008 and expect a steady recovery in confidence over the coming three months, the poll showed.
Corporate sentiment has remained negative for nearly two years as deflation squeezes profits, and domestic demand has failed to gain momentum in the wake of the global financial crisis, according to the monthly Reuters survey, taken from February 26 to March 15.
In a sign of broadening deflation, Japanese land prices fell for a second straight year in 2009 and commercial land prices sank to a record low as demand for office space and housing slumped in the wake of the financial crisis.
The next BOJ Tankan, closely watched by financial markets and a key indicator for the central bank in measuring corporate sentiment and spending plans, will be released on April 1.
Underscoring companies' uncertainty about the outlook for the economy, a government survey showed that big manufacturers grew less optimistic about business conditions in the three months to March compared with the previous quarter.
The BOJ loosened monetary policy on Wednesday following government pressure for action to overcome deflation, though the decision came on a split vote and was seen as having limited economic impact.
The Reuters Tankan survey of 400 large firms, of which 233 responded, showed sentiment in all sectors except autos improved from three months ago.
Revised data showed last week the economy grew 0.9 percent in the three months to December, slightly less than a preliminary estimate. Economists expect the recovery to slow this year but to avoid a major soft patch thanks to firm exports.
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