So rosy is the outlook that Toshihiko Fukui, governor of the Bank of Japan, appeared positively buoyant at a recent press conference during which he was able to give the most upbeat assessment of his 29-month tenure.

He refused to get carried away with all the plus-column statistics, however, opting for the safer line that the economy "has almost moved out of a pause".

Inside, however, he is likely to be doing cartwheels.

"Everyone is coming around to this optimistic attitude, with even governor Fukui hinting that we are now beginning to see external demand back on track," said Stefan Worrall, an economist with Credit Suisse First Boston in Tokyo.

Twin-engine recovery

"When that is in tandem with domestic demand, in which we have seen a surprisingly strong recovery, then they are going to fuel each other in a double-barrel recovery.

"We have not seen anything like it in Japan since the end of the bubble era," he said.

"Everyone is coming around to this optimistic attitude, with even governor Fukui hinting that we are now beginning to see external demand back on track. When that is in tandem with domestic demand ... then they are going to fuel each other in a double-barrel recovery"

Stefan Worrall, economist, Credit Suisse First Boston in Tokyo

"There are, of course, some major risks still involved," he cautioned, pointing to questions over whether the US Federal Reserve will raise interest rates and the effect that will have on US domestic consumption and, hence, external demand for Japan as well as rising global demand for oil and sharp price rises.

Despite the average retail price of oil rising 4 yen on the previous month to hit a 12-year high of 129 yen ($1.17) per litre in August, Worrall remains optimistic.

"That risk is much less when the demand is twin-engined," he explained.

"In truth, it's hard to see any downside at the moment; either the recovery will be domestic demand driven, or it will be enhanced with the external demand."

Increasing recovery

Heizo Takenaka, minister of economic and fiscal policy, pinned the pick-up in a recovery that has been noticeable since early 2002 - but had stagnated for around nine months - to rising exports, increasing personal spending and progress in adjustments in the information technology sector.

"We believe the economy has now emerged from the standstill," he told a press conference on 9 August, a situation he said the government had foreseen.

In its August economic assessment, the cabinet office failed to use the terms "weak movements" or "weak situation" for the first time since November 2004 and predicted that corporate sector resilience would continue to extend into the household sector.

And the stock market has been quick to jump on the good news, with the Nikkei index recording a steady rise ever
since.

It temporarily stood at 12,612.16 on 23 August, the highest level since 5 July 2001, before falling back to close at 12,472.93.

Confidence

In addition, 80% of companies that responded to a poll by Kyodo News said they were confident the recovery would gather pace over the next six months.

The majority also expected a rise in profits although only 26% plan to expand operations by employing more staff.

Analysts believe deflation will
ease and stocks will recover

Another positive indicator is falling office vacancies in central Tokyo.

Mimicking a similar drop in office availability in New York, office vacancies for the five main business districts of the Japanese capital are at a three and a half year low as companies expand, according to a report by private brokerage firm Miki Shoji.

It also suggested that vacancy rates will continue to decline and that average rents - which had been falling and stood at 26,222 yen per 3.3 square metres in July - have now bottomed out.

The domestic optimism is apparently infectious: the International Monetary Fund earlier in the month raised its outlook for 2005 economic growth in Japan to 1.8 % on the basis of improved personal consumption figures and private capital investment.

The same factors prompted Tokyo to make a slightly more conservative prediction of 1.6%.

Escaping deflationary spiral

And arguably the most significant impact of all the good news, according to Takuji Aida, chief economist with Barclays Capital in Tokyo, is that the economy should be able to escape from the deflationary spiral that has been afflicting it.

"We're very optimistic because until last year the Japanese economy was being affected by external factors, but domestic demand is becoming stronger and stronger and now employment statistics are getting better as well," he said.

From a peak of 5.5%, unemployment is currently running at 4.2% and Aida expects that to fall below the 5% level by the
end of the year.

"Thanks to the domestic demand, we believe the deflationary gap will end by next year, at the latest, and that stocks will broadly recover," he said.

Politics notwithstanding

And all this in spite of what Credit Suisse First Boston's Worrall describes as the ongoing "political shenanigans".

"We have seen the benefits of the changes take hold already, particularly in the first quarter of the year, and they can only go forward, irrespective of the political situation"

Stefan Worrall, economist, Credit Suisse First Boston in Tokyo

"The election on 11 September is obviously a very symbolic battle between the old and new over political and structural reform, but a lot of those reforms have already gone past the point of no return," he said, pointing to the example of banks writing off their huge non-performing loans over recent
years.

"We have seen the benefits of the changes take hold already, particularly in the first quarter of the year, and they can only go forward, irrespective of the political situation."

The only potential problem might be if the politics distracts attention from the economic front, he believes, with the currency and stock markets failing to react sufficiently to positive economic events, although the genuine risk is slight.