Moody's stripped Japan of its coveted AAA rating on its foreign currency debt on Monday, rekindling some speculation that other major economies may pay for their efforts to revive growth with credit downgrades.
Unlike many of its peers in the the top triple-A category, the world's No.2 economy relies mainly on domestic funding and Moody's combined the cut in the largely symbolic foreign rating with an upgrade by a notch to domestic government bonds.
The move, which Moody's said would unify all Japanese government debt at a new Aa2 level, had limited impact on the Japanese bond market bracing for record debt supply to finance the government's record spending.
It coincided with a survey of Japanese manufacturers that showed sentiment edged up from record lows this month, keeping alive hopes that a disastrous first quarter marked a low point in Japan's and the world economy's worst recession in six decades.
But as governments from Beijing to Washington have committed trillions of dollars to kickstart their economies, ballooning debt and deficits raised questions about the ability of nations such as United States or Britain to keep their top credit grades.
"The move to lower Japan's foreign currency bond rating from Aaa opens the way for speculation about whether Moody's will take similar actions on other triple-A ratings," said Kenro Kawano, senior rates strategist at Credit Suisse in Tokyo.
Analysts, however, did not expect markets to change their view of the local debt market, with the Japan saddled with the biggest public debt among industrialised nations, but also able to tap a vast pool of domestic savings.
"What we are seeing is an appropriate normalisation across Japan's various debt obligations. Given the size of Japan's overall public deficit it obviously should not enjoy the highest rating," said Glenn Maguire, economist with Societe Generale in Hong Kong.
LINGERING DOUBTS
Major stock markets in Europe and most of Asia fell on Monday, reflecting lingering doubts about the strength and timing of the long-awaited economic recovery as signs of improvement ahead go hand in hand with evidence of immediate pain.
Tokyo shares closed 2.4 percent down and the index of top European shares was 1 percent lower tracking Wall Street losses on Friday. But a gauge of Asian markets outside of Japan rose 1.7 percent, pulled up by gains in India, where stocks soared as much as 17 percent after a resounding election victory by the ruling Congress party.
Monday's monthly Reuters survey of Japan's top companies followed Friday's better-than-expected machinery orders data for April and a U.S. consumer survey showing confidence at its highest since last September's collapse of Lehman Brothers.
U.S. industrial output fell at a slower pace in April and a top European Central Bank policymaker also offered some encouragement on Monday, saying the ECB has already done enough to help the euro zone economy.
However, tentative signs of life came against a backdrop of deeper-than-feared first-quarter declines in the U.S. and euro zone economies and signs that companies around the world are still struggling with a slump in global trade and demand.
The euro area economy shrank 2.5 percent in January-March, more than forecast, dragged down by a sharp 3.8 percent slump in Germany, data showed on Friday.
Japan, its fortunes inseparable from its top export markets, is also expected to report it contracted 4.2 percent in the first quarter when it releases its gross domestic product data on Wednesday.
The Reuters tankan survey that closely tracks the highly influential Bank of Japan quarterly survey, showed that while the mood in the manufacturing sector brightened in May, confidence at service firms hit a record low, as the effects of the global downturn spread from Japan's top exporters to the broader economy.
BRIGHTER OUTLOOK
Both manufacturers and service sector firms expect the situation to improve over the next three months, largely as a result of re-stocking by firms that have aggressively run down their inventories since late last year.
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A separate government poll of Japanese households also showed consumer sentiment improved in April, though the majority of consumers remained pessimistic.
Yet economists and policymakers are cautiously optimistic that sharp interest rate cuts, fiscal packages and bank bailouts will eventually succeed and that the world has probably seen the worst of its recession.
Such confidence was apparent in comments from Axel Weber, Bundesbank president and ECB Governing Council member.
"Unless things get noticeably worse, in my view, the package of measures decided until now is sufficient," Weber told the Financial Times Deutschland in an interview published on Monday.
The ECB cut its benchmark rate to a record low of 1 percent earlier this month and announced a plan to buy about 60 billion euros worth of covered bonds.
