April 2 (Bloomberg) -- Japanese companies plan to invest at a faster pace than economists expected, indicating they're upbeat about the outlook for growth at home and abroad.

The Tankan, Japan's most closely watched business survey, showed large companies plan to increase spending by 2.9 percent in the year that began April 1, the Bank of Japan said in Tokyo today, beating economists' estimates. Sentiment among the nation's largest manufacturers slipped from a two-year high.

Increased spending will help Elpida Memory Inc. and Kyocera Corp. compete against Asian rivals while banks and retailers invest to meet domestic demand. Japan's labor shortage became the most severe in 15 years, the companies said, suggesting wage growth may accelerate and support consumer spending.

``Companies are going to be aggressive in their capital spending plans this year,'' said Takuji Aida, chief Japan economist at Barclays Capital in Tokyo. ``Labor shortages are intensifying so that means we'll see wages rise.''

The yen traded at 117.62 per dollar at 3:55 p.m. in Tokyo from 117.74 before the report. The yield on Japan's benchmark 10-year bond slipped half a basis point to 1.645 percent.

The Topix stock index fell 1.8 percent, led by Nippon Steel Corp., after the report showed the outlook for iron and steelmakers dropped to 31 from 46, the largest slide among all groups surveyed. The index rose as much as 0.8 percent in the morning session.

The Tankan showed manufacturer confidence fell to 23 points in March from a two-year high of 25 in December. The median forecast of 30 economists was for 24. A positive number means optimists outnumber pessimists.

Services Companies

Sentiment among large non-manufacturers stayed at a 16-year high of 22 points in March, below the 23 point forecast.

``As ever, company forecasts for the year that has just begun look conservative and are likely to be revised higher,'' said Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo. The survey ``supports our view that the economy is in a solid but unexciting growth phase.''

The spending plans by large companies beat the 1.7 percent forecast by economists. Large manufacturers plan to increase spending by 2.5 percent. Large non-manufacturers expect to boost investment by 3.1 percent, more than the 0.8 percent slated by analysts.

``We're now in a major upgrade cycle,'' said Jesper Koll, chief economist at Merrill Lynch & Co. in Tokyo. ``More robots are being put to work, more productive and more competitive factories are being built.''

Conservative Forecasts

Companies tend to be conservative in their capital expenditure estimates in the March survey and upgrade them later. In March last year companies planned to boost spending 2.7 percent. That swelled to an estimated 11.9 percent, the fastest in more than 15 years, today's survey showed.

Other reports have already signaled that companies will step up outlays on factories and equipment this year. Machinery orders had their biggest gain in five months in January.

Elpida Memory said March 30 it will borrow as much as 160 billion yen ($1.4 billion) to boost production in a bid to overtake Samsung Electronics Co. as the world's biggest maker of dynamic random access memory. Elpida raised its capital spending target in January.

Kyocera, the world's third-largest maker of solar cells, said last month it will spend as much as 30 billion yen to double production of parts used in electronics.

Labor Shortage

The shortage of labor is becoming more severe. An index of labor demand among large manufacturers fell to minus 7 in March from minus 6 in December. There have been more jobs available than applicants for more than a year.

``The second quarter is a big quarter in terms of seeing whether a tightening labor market will translate into better wage income,'' said Jerram. ``It doesn't seem realistic to expect to see a big surge in wage growth'' because the retirement of more highly paid baby boomers will hold the average down.

Japan this year will see the biggest change in work-force demographics since World War II as about 5.6 million workers born between 1947 and 1949 begin to retire over the next five years.

Large manufacturers said they expect profits to be unchanged this year, the lowest estimate given by companies in a March survey since the bank started tracking the figure in 1997. Companies estimated that profits rose 7.7 percent in fiscal 2006, the report showed. Non-manufacturers see profit falling 1.3 percent this year.

Bottom Line

``Companies know that they can't maintain profitability by just cutting costs so they are increasing spending to help shore up the bottom line,'' said Barclays' Aida. ``The profit numbers weren't particularly worrisome.''

Today's report is unlikely to deter the central bank from raising interest rates later this year. The bank doubled the key overnight lending rate to 0.5 percent in February, and wants to raise it further to avoid excessive investment and prolong the economy's longest postwar expansion.

The survey ``confirms there's no reason for much action from the Bank of Japan in the short term,'' said Chris Loong, head of currency and asset allocation at State Street Global Advisors in Sydney. Statements by two central bank board members to be appointed this month will be important signposts indicating the future direction of the bank's policy, Loong said.

Manufacturers said they expect confidence to fall in June to 20 and non-manufacturers said they expect to be more confident in June with sentiment at 23.

The Tankan, which means short-term economic outlook in Japanese, asked 10,958 companies about sales, profit, spending, hiring and overall sentiment.

To contact the reporter on this story: Lily Nonomiya in Tokyo at at lnonomiya@bloomberg.net

Last Updated: April 2, 2007 02:56 EDT