Sept. 11 (Bloomberg) -- Japan's machinery orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone companies paced the drop.

Stocks fell and bonds rose after the report indicated growth in the world's second-largest economy may cool as exports to the U.S. slow. Machinery orders, which jumped 8.5 percent in June, reflect plans for capital spending, a key driver as Japan heads for its longest postwar expansion.

``With risks over the U.S. economy looming large, we don't think the Bank of Japan can raise rates'' before March 31, said Yoshimasa Maruyama, an economist at BNP Paribas Securities Japan Ltd. ``While part of the drop is a correction from several months of strong data, this was still a considerable decline.''

The Nikkei Stock Average sank 1.8 percent, the biggest slide in a month, led by companies including Advantest Corp., a maker of chipmaking equipment. The median forecast of 30 economists surveyed by Bloomberg News was for orders to fall 5.4 percent.

Yields on Japan's benchmark 10-year bond declined 5 basis points to 1.665 percent at 4:54 p.m. in Tokyo.

Capital Spending

``The bigger-than-expected drop in today's machinery orders symbolizes that capital spending, which had been driving the economic growth in Japan forward, is losing its strength,'' said Yasunari Ueno, chief market economist at Mizuho Securities Co.

Bank of Japan Governor Toshihiko Fukui said Sept. 8 that any decision to raise interest rates depends on the economy and prices. Japan's economy expanded at a 1 percent annual pace in the second quarter, slowing from 3.3 percent in the first quarter, a Cabinet Office report showed today.

Capital spending expanded 3.7 percent in the second quarter, up from 3.3 percent in the first, the gross domestic product report showed. Exports grew 0.9 percent in the second quarter, down from 2.2 percent in the first.

Industrial production unexpectedly fell in July, wages declined for the first time in six months and sales at retailers shrank.

Orders from manufacturers fell by 18.7 percent after rising 25.6 percent in June. Orders from service companies declined 10.1 percent, led by a 26.7 percent drop in communications equipment, including computers and cell phones.

`Payback'

``We have to monitor these trends carefully to see if a general retreat in demand is in the works,'' Takehiro Sato, an economist at Morgan Stanley Japan Securities Co., wrote in a report. ``But we think the decline is mostly being driven by special factors.''

Today's drop ``is payback for strong orders in recent months,'' said Itsushi Tachi, director of business statistics at the Cabinet Office. ``The trend is for growth.''

The government forecasts machinery orders will increase 4.9 percent in the quarter ending Sept. 31.

``To reach this target, we need growth of 16 percent in August and September,'' Tachi said.

Japan's economic expansion will become the longest since World War II if it continues through November, surpassing the so- called Izanagi boom of 1965-1970, a 57-month period of growth named after an ancient god.

To contact the reporter on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net

Last Updated: September 11, 2006 04:00 EDT