Japan's recovery continues, even with the disruptions from the Kobe earthquake and soaring yen. But the upturn faces a decidedly uphill climb.

The Bank of Japan's Tankan survey, taken in February, shows that businesses are less gloomy about economic prospects. True, the net reading, which subtracts the percentage who view conditions as poor from those who answer positively, remains in negative territory. But the current -21% is better than the -27% reading of November, and the dismal -46% of a year ago (chart).

Nonmanufacturers remain cautious because of a lack of domestic pricing power, although this "price destruction" is also hurting the materials industry. Manufacturers of finished goods are more upbeat, particularly about their future output, profits, and exports.

The yen's surge, which began after the survey, may soon dim a bit of this optimism. Already, some private economists are paring their 1995 forecasts, with the economy growing closer to 2% than 3%. The reason: The strong yen will hurt exports, which have added to growth even as other sectors lag.

Specifically, capital spending, a recovery leader in the past, still shows few signs of turning up. The Tankan survey says large companies plan a 1% cut in business spending for the fiscal year starting in April, after a 5.6% drop in this fiscal year. And the companies said 24.5% of their capital budgets will be spent on foreign facilities.

Consequently, consumer spending will have to be the main source of economic strength. The January job news was positive, but hardly robust. Employment grew by a small 0.6% from December, wage growth was up slightly, and the ratio of job offers to applicants inched up to 0.66, from 0.64.

Still, healthier labor markets and a bit brighter business sentiment are good signs for Japan's recovery. But the mild improvement

in the data and the yen's new strength indicate that the upturn will move in fits and starts, rather than at a smooth upward pace.

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