Tokyo Market: Rising yen clouds positive outlook

Japanese stocks may have mixed fortunes this week, with banks getting a boost from expectations that mergers will improve profits, while exporters worry that a rising yen will reduce their earnings.

Sanwa Bank and other lenders gained last week as two merger announcements bolstered optimism that a fully fledged consolidation of Japan's financial industry is under way. Speculation that other institutions may reveal similar plans will probably push shares higher this week, as investors bet that a shake-out will result in fewer but stronger banks.

But exporters like Sony and Honda may retreat if the yen extends gains against the dollar. The Japanese currency rose in the last three days on concern that the US economy may be dragged down by a financial crisis in Latin America.

"The market has come around to the view that a shake-out in the banking industry is just what the doctor ordered," said Shigemi Nonaka of Sanyo Investment Management. "But a real recovery by stocks will be impossible until corporate earnings turn around, and the yen is a big barrier for the exporters."

The Nikkei 225 average will probably trade between 13,900 and 14,300, investors say. The benchmark index rose 3 per cent last week to 14,145.04.

Sanwa, Japan's third-largest bank, posted its biggest one-day gain since October after it said it would merge its trust unit with Toyo Trust & Banking. Reports have suggested that other institutions are preparing similar moves.

"Traders have been betting heavily against the weaker banks, and most investors are underweight in the industry," said Yoshio Inamura at Tokyo- Mitsubishi Asset Management. "Signs that the overcapacity issue is finally being addressed have both sets of players looking to get back in."

But gloom may descend if Brazil's financial ills pull down the dollar and US stocks. "The heaviest drags are the dollar-yen exchange rate and Wall Street," said Mr Nonaka.

Some investors are seeking to shake off those drags by reshuffling their portfolios to include more domestic industry leaders such as NTT Data. Investors are also pursuing "restructuring plays" - companies like Toshiba which have announced far-reaching cost-cutting programmes.

Japanese bonds are likely to be little changed as concern that a glut of bonds flooding the market will sap demand at a sale of 10-year bonds offsets the outlook for deflation and low short-term interest rates.