Dec. 7 (Bloomberg) -- Japan's third-quarter expansion was slower than the government initially reported, the latest evidence growth is losing steam because of a slump in domestic housing construction and waning U.S. demand.

The world's second-largest economy grew an annualized 1.5 percent in the three months ended Sept. 30, the Cabinet Office said in Tokyo today. The government was expected to keep its preliminary estimate of 2.6 percent unchanged, according to the median forecast of 25 economists surveyed by Bloomberg News.

The report was revised to account for a survey this week that showed spending on factories and equipment fell in the quarter, companies ran down inventories and profits fell for the first time in five years. Bond futures halted a two-day slide as today's numbers cemented expectations the Bank of Japan will delay raising interest rates, the lowest among major economies.

``Japan's economy is losing momentum,'' said Seiji Adachi, a senior economist at Deutsche Securities Inc. in Tokyo. ``Slowing capital spending was a drag because companies can't pass higher costs of oil and raw materials onto consumers and clients.''

The yen traded at 111.34 per dollar at 12:33 p.m. in Tokyo from 111.33 before the report was published. The yield on Japan's five-year bond fell half a basis point to 1.06 percent.

The economy shrank an annualized 1.8 percent in the second quarter, the Cabinet Office said today, revising its earlier estimate of a 1.6 percent contraction.

Export-Led

On a quarter-on-quarter basis, the economy expanded 0.4 percent, slower than the 0.6 percent reported Nov. 13. Business investment grew 1.1 percent in the quarter, less than the 1.7 percent first reported.

``Rising oil prices are weighing on capital spending, especially among self-employed companies,'' Economic and Fiscal Policy Minister Hiroko Ota said. Today's report doesn't change the government's view that the economy is recovering, she added.

Hopes were dashed that demand at home would join exports to drive the economy's expansion. Domestic demand detracted 0.1 percentage point from third-quarter growth, revised from a 0.2 percentage point contribution.

Net exports, or the difference between exports and imports, added 0.5 percentage point, more than the 0.4 percentage point first reported, as imports fell. Shipments to China and Europe helped exports surge to a record in October even as sales fell in the U.S., Japan's largest overseas market.

Still Buying

``The rest of the world is still buying Japanese products,'' said Akira Maekawa, an economist at UBS Securities Japan Ltd. ``The economy will keep growing but at a slower pace.''

Consumer spending rose 0.3 percent from the second quarter, the Cabinet Office said, unchanged from the preliminary survey.

The Bank of Japan's quarterly Tankan business survey next week will probably show a drop in confidence of large manufacturers for the first time since March, economists said. The bank will hold off raising its key interest rate from 0.5 percent until at least the second quarter of 2008, according to 21 of 30 economists surveyed by a government think tank.

A rate increase is ``off the agenda,'' said Uwe Parpart, chief Asia economist at Cantor Fitzgerald in Hong Kong. ``There's nothing happening on the inflation side and the economy has underperformed consistently with the Bank of Japan's forecasts.''

The economy may be stalling, a government report showed yesterday. The leading index, a composite of 12 indicators including housing starts and stock prices, has been signaling a slowdown for three months.

Pessimistic Consumers

Consumer sentiment is at a three-year low, retail gasoline prices are at a record and the Nikkei 225 Stock Average has slumped 12 percent in the past six months. Housing starts tumbled 35 percent in October, the fourth monthly drop, after new government regulations choked off building permits.

``Basically the domestic economy is soft and you have this whole mess with the housing sector making things worse,'' said Hiroshi Shiraishi, an economist at Lehman Brothers in Tokyo. ``We're pretty cautious about the U.S. and we're worried the yen might appreciate sharply.''

Housing won't recover until April, according to the Building Contractors Society, which represents 69 of Japan's biggest construction companies.

Global growth is also showing signs of cooling. The Goldman Sachs Global Leading Index decelerated to 2.1 percent in November from 2.4 percent in October because of worsening corporate and household sentiment in Europe and the U.S.

Central bank Governor Toshihiko Fukui said this week that he's closely watching the U.S. to determine whether the housing recession there damps spending and causes growth to slow more than expected next year.

The yen has risen more than 8 percent against the dollar in the past six months, eroding exporters' profits. Canon Inc., which makes three quarters of its sales outside Japan, reported its first profit drop in two years in the third quarter. The maker of photocopiers and cameras last month also cut its annual sales estimate because it had earlier assumed the yen would trade around 115 against the dollar.

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

Last Updated: December 6, 2007 22:39 EST