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Confidence among U.S. consumers unexpectedly dropped in December to a record low as Americans grew increasingly concerned about jobs, raising the risk that spending will keep weakening into the new year.

The Conference Board’s index of consumer confidence fell to 38, the lowest level since records began in 1967, from 44.7 in November, the New York-based private research group said today. Another report showed declines in property values accelerated.

Rising unemployment, mounting foreclosures and declining household wealth have dimmed the outlook for consumer spending, which accounts for 70 percent of the economy. This year’s holiday season, the most important for retailers, was probably the worst in at least four decades.

“The deterioration going on right now in the labor market made people feel much worse,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. “If people are worried about their jobs, they are not going to spend. That is extremely negative.”

Economists surveyed by Bloomberg News forecast the confidence figure would increase to 45.5 from a previously reported 44.9 for November, according to the median of 52 projections. Estimates ranged from 40 to 51.1.

Earlier today, reports showed the decline in home prices accelerated in October as credit dried up and foreclosures mounted, and business activity in December contracted for a third month.

Home Prices Drop

The S&P/Case-Shiller home-price index of 20 U.S. metropolitan areas fell a record 18 percent in October from a year earlier, led by declines in Phoenix and Las Vegas. All 20 cities showed a decline in the year ended in October.

The Institute for Supply Management-Chicago said its business index climbed to 34.1 this month from a 26-year low of 33.8 in November. Readings less than 50 signal contraction.

Stocks trimmed gains following the reports and Treasury securities fell. The Standard & Poor’s 500 index rose 0.7 percent to 875.7 at 10:15 a.m.

The share of consumers who said jobs are plentiful fell to 6.2 percent, the lowest level in 16 years, from 8.7 percent last month, today’s report showed. The proportion of people who said jobs are hard to get increased to 42 percent from 37.1 percent.

Americans’ views about their financial well-being in future months deteriorated. The Conference Board’s gauge of the outlook for the next six months decreased to 43.8 from 46.2 in November payday cash advance.

The share of respondents expecting their incomes to rise over the next six months fell to 12.7 percent from 13.1 percent. Americans were more hopeful of finding jobs in the future.

The measure of present conditions dropped to 29.4 from 42.3.

‘Dismal’ Outlook

“The overall economic outlook remains quite dismal for the first half of 2009,” Lynn Franco, director of the Conference Board’s consumer survey, said in a statement.

The grimmer view on jobs swamped the effects of the drop in gasoline prices that helped other confidence measures climb this month. The Reuters/University of Michigan’s sentiment gauge rose from November’s 28-year low.

The average price of a gallon of regular gasoline dropped to $1.62 on Dec. 28, down 61 percent from July’s record.

Even so, the decline isn’t enough to undo the damage from the loss of 1.9 million jobs so far this year and the record destruction in household wealth caused by the slump in home and stock prices.

Economy to Shrink

Gross domestic product contracted at a 0.5 percent annual pace in the third quarter, the worst performance in seven years, the Commerce Department said last week. Economists surveyed by Bloomberg earlier this month projected the economy will contract at a 4.3 percent rate this quarter, hurt by another decline in consumer spending.

The jobless rate could reach 8.2 percent at the end of next year compared with last month’s 15-year high of 6.7 percent, according to the survey.

President-elect Barack Obama has expanded his economic stimulus goals and called for creating or saving 3 million jobs over the next two years. Vice President-elect Joe Biden said Dec. 23 the incoming administration and congressional leaders are nearing an agreement on the broad principles of a stimulus policy.

The International Council of Shopping Centers projects this was the worst holiday shopping season, the most important period for retailers, in at least four decades.

“It’s dismal,” Patrick Byrne, chief executive officer of Overstock.com, the Internet seller of discounted brand-name goods, said Dec. 24 in an interview on Bloomberg Television. “It seems the entire retail nation is running a going-out-of-business sale. It means the pricing is very competitive.”

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South Korea’s economy may shrink in the first and second quarters of next year, affected by a global economic slowdown, President Lee Myung Bak said today.

“The world economy is difficult and South Korea is heavily dependent on the external side,” Lee said at a meeting at the presidential house in Seoul today, according to his office Web site. “Even though we may post positive annual growth, we’re in danger of negative growth in the first and second quarters.”

South Korea’s economy will expand 2 percent, the slowest pace in 11 years, in 2009 as the deepening global recession cools demand at home and abroad, the central bank said on Dec. 12. The economy last contracted for two consecutive quarters in 1998, and Lee’s comments come after he pledged last week to ensure growth next year.

“Negative growth is unavoidable,” said Chun Chong Woo, senior economist at SC First Bank Korea Ltd. “We’re bound to be affected by the global slump, and the government will have to think of more aggressive policies to help spur the economy.”

Exports of goods will rise 1.3 percent, slowing from an estimated 3.6 percent gain in 2008, the central bank forecast in its 2009 outlook. The nation targets exports of $450 billion next year, the Minister of Knowledge Economy said yesterday, trimming its November forecast of $500 billion payday loans.

Cut & Stimulate

South Korea should use interest-rate cuts and fiscal stimulus to cushion the economy from the global recession and avoid depleting its foreign-currency reserves to prop up the won, the Organization for Economic Cooperation and Development said on Dec. 17.

The Bank of Korea has cut its key rate by 2.25 percentage points since October, the most aggressive easing since it first set a benchmark in 1999. The bank most recently cut the benchmark rate by 1 percentage point to a record low 3 percent on Dec. 11.

South Korea is also pumping funds into banks, cutting taxes and boosting public spending to limit the fallout from the global credit crisis, which sent the Korean won down more than 28 percent and the stock index tumbling 41 percent this year.

“We see the first and second quarters to be the bottom,” Lee said. “There’s hardly any country posting economic growth from the fourth quarter to the first quarter.

“There is an end to this agony,” he said. “It won’t last 10 or 20 years.”

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Japan’s recession deepened in November as companies cut production at the fastest pace in 55 years and rising unemployment prompted households to pare spending.

Factory output plunged 8.1 percent from October, the Trade Ministry said today in Tokyo, more than the 6.8 percent estimated by economists. The jobless rate climbed to 3.9 percent from 3.7 percent. Household spending slid 0.5 percent, a ninth drop.

Simultaneous recessions in the U.S. and Europe have weakened demand for Japan’s exports, prompting companies from Toyota Motor Corp. to Sony Corp. to idle plants and fire workers. The Bank of Japan has little room to spur the economy after cutting interest rates close to zero last week, and Prime Minister Taro Aso has yet to implement two stimulus packages.

“We’re not at the worst yet,” Kyohei Morita, chief Japan economist at Barclays Capital in Tokyo, told Bloomberg Television. “In terms of the stimulation of the real economy, what matters is fiscal policy, not monetary policy.”

The yen traded at 90.43 per dollar as of 1:26 p.m. in Tokyo from 90.46 before the reports. The Nikkei 225 Stock Average rose 0.8 percent. The gauge has lost 43 percent this year, heading for its worst annual decline. The yield on Japan’s 10-year bond fell 2 basis points to 1.195 percent, matching a three-year low.

The decline in production was the biggest since comparable figures were first made available in February 1953. Shipments also fell the most on record. The ministry downgraded its assessment of output, saying it’s “declining rapidly.”

No End in Sight

There’s no end in sight to the recession that began when the economy shrank in the past two quarters. Companies surveyed by the ministry planned to reduce output a further 8 percent this month and 2.1 percent in January. Should December’s forecast be realized, production would slide a record 11.1 percent this quarter.

“The output numbers were just horrible,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. “Economic conditions are going to deteriorate rapidly.”

Fuji Heavy Industries Ltd. announced additional production cuts today. The maker of Subaru-brand cars will lower output by a further 10,000 vehicles in the year ending March, bringing total reductions to 70,000 worldwide. It will also shed 300 temporary jobs on top of 800 eliminations announced last month.

Japan’s exports plunged 26.7 percent in November, the sharpest drop since at least 1980, a report showed this week.

The Bank of Japan last week lowered its benchmark interest rate to 0.1 percent, increased purchases of government debt and announced plans to buy commercial paper for the first time.

Signs of Deflation

The inflation rate eased the most in a decade in November as prices of oil and other commodities plunged, indicating deflation may be returning to the world’s second-largest economy pay day loans. Consumer prices excluding fresh food rose 1 percent from a year earlier, the slowest pace since April, the statistics bureau said today.

“Data clearly indicate the problem for Japan is deflation, not inflation,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo.

Economic and Fiscal Policy Minister Kaoru Yosano said “the government, companies and politicians need to make an effort to keep the economy from falling apart next year.” Prime Minister Aso has unveiled two stimulus plans since becoming Japan’s leader in September; both await approval by parliament.

The measures “may help to ease the economy’s decline once they’re actually implemented,” Masamichi Adachi, a senior economist at JPMorgan Chase & Co. in Tokyo, said on Bloomberg Television. “But there’s still little hope that Japan’s economy will show any clear signs of a turnaround in 2009.”

Yen Pain

The yen’s 23 percent gain against the dollar this year is compounding exporters’ woes by eroding their profits. Japan’s currency surged to a 13-year high of 87.14 on Dec. 17.

Japanese carmakers have been hit by the recession in the U.S., where consumer credit is drying up and households are spending less. Toyota this week forecast its first operating loss in seven decades for the year ending March. Last month the automaker, the world’s second largest, said it would fire 3,000 temporary staff.

Temporary and part-time workers are the hardest hit by the downturn. Companies plan to fire 85,012 such staff by the end of the business year, more than double the 30,067 forecast last month, the Labor Ministry said today.

The ratio of jobs available to each applicant dropped for a 10th month in November to 0.76, extending the longest losing streak since 1998. Wages fell 1.9 percent, the most in four years, underscoring why consumer sentiment slumped to a record low.

Retail sales slid 0.9 percent from a year earlier, the biggest drop in 16 months, the Trade Ministry said today. Weaker personal spending is prompting retailers to reconsider investments.

LVMH Moet Hennessy Louis Vuitton SA last week scrapped plans to open a 12-story Tokyo store. Isetan Mitsukoshi Holdings Ltd., Japan’s largest department store, will delay renovating its two flagship outlets in Tokyo, broadcaster NHK reported last week.

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China cut interest rates for the fifth time in three months to support the world’s fourth-biggest economy after trade growth collapsed because of recessions in the U.S., Europe and Japan.

The one-year lending rate will drop by 0.27 percentage point to 5.31 percent and the deposit rate by the same amount to 2.25 percent from tomorrow, the People’s Bank of China said on its Web site. The central bank also reduced the proportion of deposits lenders must set aside as reserves by 0.5 percentage point.

Exports fell for the first time in seven years last month, imports plunged and manufacturing contracted by a record. China’s slowdown will deepen before a 4 trillion yuan ($584 billion) stimulus package kicks in from the second quarter of next year, Liu He, a senior policy official, said Dec. 12.

“The central bank won’t stop the rate-cutting cycle until the economy starts to recover,” said Li Wei, an economist at Standard Chartered Bank Plc in Shanghai. “It may not boost borrowing, but the government needs to show that it’s doing something.”

The reserve requirement will drop to 15.5 percent for big banks and to 13.5 percent for smaller ones effective Dec. 25.

China reduced rates by the most in 11 years last month and announced the package of spending through 2010 on infrastructure and low-cost housing. The State Council pledged Dec. 13 to boost money supply by 17 percent next year to encourage lending and buoy domestic consumption.

Still, economic growth may slump to 5 percent in the first half of next year, less than half the 11.9 percent expansion in all of 2007, according to Royal Bank of Scotland Plc health insurance.

The slowdown threatens to trigger social unrest as factories close and unemployment climbs in the world’s most populous nation. It may also reduce the nation’s contribution to global growth, forecast by Merrill Lynch & Co. at 80 percent next year.

Uniden Corp., a Japanese maker of wireless communication gear including cordless phones, said Dec. 11 it will eliminate 6,200 jobs in China. Zhang Ping, China’s top economic planner, warned last month of the risk of “massive unemployment.”

Besides the trade collapse, weakness in the property market is undermining investment, construction, consumption and economic growth. Home sales dropped 20.6 percent in the first 11 months from a year earlier, according to the statistics bureau.

The government has switched from battling inflation in the first half of the year to guarding against the risk that falling prices will contribute to the economy spiraling down. Inflation was the slowest in 22 months in November.

China needs to prepare for a “worst case scenario” as the global economic slump deepens, central bank Governor Zhou Xiaochuan said Dec. 4.

China’s economy will expand by 7.5 percent next year, the least in almost two decades, the World Bank forecast last month. The nation is targeting an 8 percent expansion to generate jobs and avoid social instability, China Banking Regulatory Commission Chairman Liu Mingkang said in Beijing on Dec. 13.

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Treasury Secretary Henry Paulson urged Congress to release the second half of the $700 billion financial rescue fund after the government exhausted the first $350 billion in less than three months.

Congress, which passed the Troubled Asset Relief Program on Oct. 3, “will need to release the remainder of the TARP to support financial market stability,” Paulson said today in a statement released in Washington.

The Treasury today agreed to lend $13.4 billion to General Motors Corp. and Chrysler LLC, after spending $335 billion mostly to increase bank capital. Lawmakers, who can vote against giving Paulson the remaining funds, have criticized the Bush administration for not using the rescue package to help stem foreclosures.

Paulson’s call for the other $350 billion may set off a debate in Congress, where some members have demanded more help for struggling homeowners. House Financial Services Committee Chairman Barney Frank said today he’s crafting legislation to unlock the unallocated money.

Today’s statement from Paulson wasn’t a formal request for the funds, a move President George W. Bush or his successor would have to make. Paulson intends to consult with Congress and President-elect Barack Obama’s staff on the strategy for officially requesting the next $350 billion, a Treasury official told reporters on a conference call. The official, who spoke on condition of anonymity, said he expected talks to begin soon.

Need Agreement

“We should have an agreement among Obama, Paulson and the congressional leadership to release the $350 billion with conditions on how it’s spent,” Frank said in an interview. “We need the second $350 billion, but it can only be done if there’s an agreement as to how to do it.”

Obama said yesterday that Paulson would need to explain to his staff how the funds would be disbursed.

“At the point where the Treasury comes forward” with a request for the remainder of the TARP, “I would expect that they would provide a clear justification for why they need additional dollars and how they intend to use it,” Obama said in a press conference in Chicago bad credit pay day loans.

In his statement, Paulson said he would consult with congressional leaders and the Obama team “in the near future.”

The Treasury likely would need to come up with a program for helping homeowners before Congress signs off on a request for the funds.

Another $4 Billion

The loan package for the automakers released today has another $4 billion contingent on “drawing down the second tranche of TARP funds,” according to a White House statement.

“It’s not necessarily true that this administration in the remaining 31 days, I believe, will go back to Congress,” said Joel Kaplan, the White House deputy chief of staff, said in a press conference. “But in the very short term, we will need to go — we, or the next administration — will need to go to Congress to get the second $350 billion if they are to get the last chunk of the loan that’s being discussed today.”

Treasury officials have been working on programs designed to ease the housing crisis.

Most Republicans on Capitol Hill are opposed to giving Paulson any additional funds. Still, Democrats may take Paulson’s actions on housing and the car industry as positive steps and not mount a campaign against the request, lobbyists and congressional staff said.

Banking Stability

Securing the extra money would give the Treasury a cushion in case another bank or insurer neared collapse.

While the Treasury has allocated most of the first $350 billion, not all of it has actually been disbursed. Paulson said he was confident that “in the very short-term” the government has enough money on hand to “address a significant financial market event.”

To access the rest of TARP, Paulson has to report to Congress on how the funds would be used. Lawmakers then have 15 days to pass legislation blocking the money. The president could then veto the congressional vote, forcing lawmakers to come up with a bigger majority to prevent the disbursement.

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A gauge of the economy’s future performance posted its biggest annual drop since 1991 in November as the declines in housing and job markets accelerated, showing little sign the U.S. contraction will ease in early 2009.

The Conference Board’s index of leading indicators dropped 0.4 percent from October, and 3.7 percent from a year before. Other reports showed first-time claims for unemployment benefits held close to a 26-year high and manufacturing in the Philadelphia region contracted for the 11th time this year.

The drop in the leading index underscores economists’ projections that the recession will be the longest in the postwar era as banks restrict credit, home and stock values plunge and job losses mount. President-elect Barack Obama reiterated today that his top priority is a stimulus plan that spurs demand and creates new jobs.

“There is no end to the recession in sight,” said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh, who correctly forecast the decline in the leading index. “The economy is likely to continue to fall hard.”

Treasury securities maintained gains following the reports as concern over the deepening economic slump persuaded investors to accept almost record-low yields to safeguard their money. Yields on benchmark 10-year notes fell to 2.10 percent at 1:03 p.m. in New York. The dollar slid 0.9 percent to $1.4289 per euro. The Standard & Poor’s 500 Stock Index was little changed.

Jobless Claims

The number of Americans filing first-time applications for unemployment benefits dropped by 21,000 to 554,000 in the week that ended Dec. 13, from a 26-year high of 575,000 the prior week, the Labor Department said today.

“This is exactly the stage of the recession where businesses are aggressively cutting employment,” Mickey Levy, chief economist at Bank of America Corp. in New York, said in a Bloomberg Television interview. “I expect the pace of layoffs to continue.”

The Philadelphia Federal Reserve Bank’s manufacturing index registered a reading of minus 32.9 this month, higher than anticipated, compared with minus 39.3 in November. Negative readings signal contraction.

Economists projected the leading index would drop 0.4 percent, according to the median of 55 forecasts in a Bloomberg News survey. The measure has fallen in five of the past seven months.

Six of the 10 leading indicators subtracted from the index, led by a slump in building permits, plunging stock prices and increasing jobless claims.

Housing Rout

The drop in building permits to a record low last month subtracted almost a half point from the leading index.

The other negative categories included a decline in the factory work week, a drop in consumer expectations and shorter supplier delivery times that indicate a drop in orders.

A surge in the money supply adjusted for inflation, which has the biggest weighting in the index, prevented the gauge from falling even more cheap pay day loans. The measure added 0.6 percentage point.

The economy entered a recession in December 2007, the National Bureau of Economic Research announced Dec. 1. Economists surveyed by Bloomberg this month forecast continued contraction in the first half of 2009, making this the longest slump since the end of World War II.

The Conference Board’s index of coincident indicators, a gauge of current economic activity, fell 0.3 percent, after increasing 0.3 percent the prior month. The index tracks payrolls, incomes, sales and production, the figures used by the NBER to determine the start of recessions.

2007 Peak

The coincident index peaked in October 2007, two months ahead of the start of the downturn.

Obama may ask Congress next year to approve a stimulus plan of around $850 billion, according to a transition adviser. The amount would exceed initial estimates by House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, as well as surpassing what some economists and the International Monetary Fund say is required.

Fed policy makers on Dec. 16 said they will target a federal funds rate of between zero and 0.25 percent and buy unlimited quantities of debt as the next step in combating the recession.

“The outlook for economic activity has weakened further,” the Fed said in a statement. The central bank said it “will employ all available tools” to revive growth and preserve price stability.

AutoNation Pain

Mike Jackson, chief executive officer of AutoNation Inc., the largest publicly traded U.S. car retailer, said sales have declined “practically to a standstill” because lenders are retrenching.

“The credit is simply not there from the financial institutions to finance those customers: they’re turning away very good customers,” Jackson said in a Bloomberg Radio interview on Dec. 4.

The Conference Board’s gauge of lagging indicators rose 0.1 percent after no change in the prior month. The index measures business lending, length of unemployment, service prices and ratios of labor costs, inventories and consumer credit.

The end of the recession won’t be signaled until the leading index and the ratio of coincident-to-lagging indicators turns positive for at least three months in a row, said Conference Board economist Ken Goldstein in an interview yesterday.

Still, “that would only mean the recession was losing steam, not that we were off and running,” Goldstein said, adding the data is unlikely to turn positive any “earlier” than the third quarter of next year.

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The Federal Reserve opened a new era in U.S. monetary history, cutting interest rates to as low as zero and pledging to buy unlimited quantities of securities, after conventional policies failed to arrest what may be the worst recession since World War II.

The new strategy is likely to involve unusually close cooperation with the Treasury of President-elect Barack Obama, which is still formulating its economic-rescue plans. The aim is to kick-start borrowing and spending to propel the economy toward a recovery by the middle of next year.

“It’s going to take a combination of fiscal and monetary stimulus to get the job done,” said former Fed Governor Lyle Gramley, now senior economic adviser at Stanford Group Co. in Washington. The central bank has signaled it will “make sure that the fiscal stimulus package, which is going to be a big one, is fully supported” and “in effect financed by the Fed.”

Possible steps by the Fed in coming months include financing for a new package to shore up the housing industry, and expanding a $200 billion program to undergird credit card and student loans. The new plan is risky: market pricing could be distorted for months or years, with insolvent borrowers kept afloat as central bankers force yields below levels investors deem appropriate given the risks.

The Fed’s Open-Market Committee yesterday said it will use “all available tools” to generate a resumption in growth. The FOMC also effectively retired its benchmark interest rate, bringing the target for overnight loans between banks down to zero to 0.25 percent from 1 percent previously.

Investors React

Stocks surged as the clarity of the Fed’s commitment exceeded some investors’ forecasts. Treasuries jumped in anticipation of Fed purchases, and mortgage bonds rallied. The Standard & Poor’s 500 Stock Index rose 5.1 percent to a five- week high. Benchmark 10-year note yields fell more than a quarter point, to 2.26 percent.

Among new ideas the Fed is open to is buying lower-rated securities, with backing from the Treasury, a senior Fed official told reporters yesterday in Washington. Central bankers plan to discuss possible strategies with Obama’s Treasury, the person said.

Obama’s pick for Treasury secretary is Timothy Geithner, the president of the New York Fed, who has been Bernanke’s closest adviser on the emergency lending programs that the central bank has already introduced during the 16-month financial crisis.

Obama Meeting

Obama met with Geithner, former Treasury Secretary Lawrence Summers and other members of his economic team yesterday in Chicago as he assembles plans for a two-year fiscal stimulus package after he takes office Jan. 20. Among his other priorities is a new, comprehensive effort to use taxpayer funds to stem record mortgage foreclosures.

“We are running out of the traditional ammunition that is used in a recession,” Obama said at a news conference yesterday. While the Fed is going to have “more tools available to it, it is critical that the other branches of government step up,” he said payday loans for bad credit.

The Fed said yesterday it may expand its $600 billion initiative to buy debt issued or backed by government-chartered mortgage-finance companies. It is also “evaluating” purchases of longer-term Treasury securities.

“The only meaningful limitation right now is their capacity to be creative,” said David Resler, chief economist at Nomura Securities International Inc., New York. “The Fed is telling us there is just about nothing off the table.”

Other existing programs include an unlimited effort to buy commercial paper from companies and financial firms and a backstop for money-market mutual funds.

Targeted Strategy

The central bank can make a difference in credit markets where yields are higher than they would otherwise be because of a lack of liquidity due to the financial crisis, the senior Fed official said. Still, inserting the Fed as a main purchaser in those markets raises the danger of delaying a recovery in private lending, some observers said.

“The availability of Fed credit might deter private credit,” said Vincent Reinhart, resident scholar at the American Enterprise Institute in Washington and former director of the Division of Monetary Affairs at the Fed Board. “The lender of last resort becomes the lender of only resort.”

The composition and size of the balance sheet will be the Fed’s new policy focus, the senior central bank official said in a conference call. Unlike Japan’s quantitative easing policies earlier this decade, the Fed is targeting specific assets for purchase to lower credit spreads rather than expanding the amount of cash in the banking system, the senior official said.

‘American Style’

“Quantitative easing American style is what they’re giving us,” said Allen Sinai, chief global economist at Decision Economics Inc., New York. “The Japanese style was to buy government maturities. The U.S. style is directly buying agency securities, buying mortgage-backed securities and lending money right into the private sector.”

The central bank is also considering whether to provide more information about the composition and targeted size of its balance sheet, the senior Fed official said on condition of anonymity.

“The focus of the committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level,” the FOMC said.

The deepening economic slump pushed unemployment to 6.7 percent last month, the highest level since 1993, while builders broke ground on the fewest new homes since record-keeping began in 1947.

Consumer prices fell the most on record in November, the Labor Department said Tuesday. Fed officials don’t see an immediate risk of a collapse in prices, or deflation, the senior official said.

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Sentiment among Japan’s largest manufacturers fell the most in 34 years, signaling companies are likely to cancel spending plans and cut more jobs, pushing the economy further into recession.

An index that measures confidence among large makers of cars and electronics dropped to minus 24 from minus 3, the Bank of Japan’s quarterly Tankan survey showed today. A negative number means pessimists outnumber optimists.

The yen’s surge to a 13-year high last week has compounded woes for Japanese manufacturers who are already reeling from a collapse in export markets. Job cuts by companies including Sony Corp. and Toyota Motor Corp. have brought the recession home to households and increased the risk of a prolonged slump.

“The overseas situation is worsening so quickly and so dramatically; it’s really getting dangerous,” said Tomoko Fujii, head of economics and strategy at Bank of America Corp. in Tokyo. “The next few months are going to be a very severe period.”

The drop in confidence, which was in line with economists’ expectations, didn’t dissuade investors from buying stocks on speculation U.S. authorities will help General Motors Corp. and Chrysler LLC avoid bankruptcy. The Nikkei 225 Stock Average climbed 4.7 percent in morning trading in Tokyo. The gauge is down 44 percent this year.

Bank of Japan Governor Masaaki Shirakawa and his colleagues will discuss the Tankan result at a policy meeting ending Dec. 19. The board will probably keep its benchmark interest rate at 0.3 percent at the gathering, according to all 11 economists surveyed by Bloomberg News.

Rate Cut ‘Option’

The bank lowered the rate for the first time in seven years in October, and another cut at some point “is an option,” former Deputy Governor Toshiro Muto said in an interview on Dec. 11. Still, he added, “with the interest rate already so low, a further reduction would have only a limited impact.”

The 21-point decline in the large-manufacturer index was the biggest since February 1975. In the current survey’s 34-year history, only a 26-point drop during the first oil shock in August 1974 was larger.

Sentiment among large non-manufacturers fell to minus 9 from 1, entering negative territory for the first time in five years, the central bank said. Large companies said they plan to cut spending 0.2 percent in the year ending March.

“The global financial crisis has caused serious damage to exporters but the repercussion effects are spreading,” said Takahide Kiuchi, chief economist at Nomura Securities Co. in Tokyo.

Gloomy Automakers

Sentiment among automakers plunged to minus 41 from 5, the steepest drop ever. Japanese carmakers have been hardest hit by the recession in the U.S., where consumer credit is drying up and household confidence is close to a record low advance payday loans.

Toyota, which forecasts profit will fall 74 percent this fiscal year, last month said it will halve its temporary work force to 3,000 employees. The company is considering production and investment cuts in India, Brazil, China and the U.S.

The yen’s 17 percent gain against the dollar since September has lowered the value of overseas sales and undermined the competitiveness of Japanese cars, cameras and televisions.

Japan’s currency traded at 90.95 per dollar from 90.68 before the Tankan was published and 88.53 on Dec. 12, the strongest since August 1995. Large manufacturers expect the yen to trade at 103.32 in the year ending March, the survey showed.

The world’s second-largest economy shrank in each of the past two quarters, entering the first recession since 2001. Companies will keep trimming production and payrolls in coming months, prolonging the downturn, said Bank of America’s Fujii.

Too Many Workers

“The recession is likely to persist through the first half of next year,” Fujii said. “We have tighter lending conditions, excess capacity, excess labor — these all point to downside risks in the pipeline.”

The capacity index for large manufacturers climbed to 11 points from 2, the highest since March 2004. A measure of labor demand rose to a four-year high of 8 from minus 2, the first time companies said they had too many workers since 2005.

Sony last week said it would fire 16,000 employees worldwide, including 8,000 full-time staff. Canon Inc., Sharp Corp. and Nissan Motor Co. eliminated temporary and part-time positions over the past month, pushing consumer sentiment to a record low and stoking anxiety among voters.

Prime Minister Taro Aso, facing tumbling approval ratings, last week announced his second economic stimulus package since becoming leader in September. Aso still hasn’t submitted a bill to parliament to fund measures announced in October.

LDP Rift

The ruling Liberal Democratic Party may split apart before elections required by September 2009 because lawmakers don’t believe victory is possible under Aso, independent lower-house member Kenji Eda said last week.

Big companies expect business to get worse in coming months. Large manufacturers see their index falling to minus 36 in the next survey in April, and service companies expect a drop to minus 14 points.

Some economists downplayed the result.

“These forward-looking indicators have a rather poor track record when it comes to predictions,” said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong. “It could have been a whole lot worse.”

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More than a year into the credit crisis, Federal Reserve Chairman Ben S. Bernanke is still trying to establish how far he’s willing to go to aid troubled companies.

Bernanke, in a letter released yesterday, rejected the idea that the central bank should provide assistance to automakers, saying that such aid would involve the Fed in “industrial policy,” an area best left to Congress. The letter came in response to a Dec. 3 inquiry from Senate Banking Chairman Christopher Dodd.

The exchange reflects uncertainty over the limits of the Fed’s willingness to act following conflicting signals Bernanke has sent this year. While the Fed rescued Bear Stearns Cos. and American International Group Inc., it refused to intervene on behalf of Lehman Brothers Holdings Inc. — only to see Lehman’s failure trigger widespread losses and worsen the credit crisis.

Bernanke is attempting to re-establish a clear line: that the central bank will only assist firms vital to the financial system, a definition that would exclude companies such as General Motors Corp.

“He’s absolutely right to draw that line,” Martin Feldstein, the Harvard University economist who chaired President Ronald Reagan’s Council of Economic Advisers, said in an interview with Bloomberg Television. The Fed is responsible for the “health and stability of the financial sector,” and “it would be a very big departure to start doing auto companies and who-knows-what-else,” Feldstein said.

‘Healthy’ Finance

Bernanke’s comments came in a letter dated Dec. 5 to Dodd, who requested the Fed chief’s position on the automakers’ reorganization plans and whether the central bank has authority to lend to the companies.

“American manufacturing is just as important to our nation’s economy as a healthy financial sector,” Dodd said in a statement. “I look forward to continuing my oversight and work with the Fed to accomplish the goals that we both agree will secure American jobs and stabilize our economy.”

Congressional Democrats and White House negotiators last night agreed on the outlines of a $15 billion plan to give GM and Chrysler LLC federal loans to stay in business while requiring them to restructure their operations.

“Bipartisan hard work has paid off and I understand an agreement has been reached,” Senator Carl Levin, a Michigan Democrat, said in a statement late yesterday. GM and Chrysler have said they need at least $14 billion in combined aid to keep from running out of cash by early next year.

Car Czar

The legislation would include the appointment of a so- called car czar who could force the companies into Chapter 11 bankruptcy if the companies don’t come up with their own plan by March 31, a Bush administration official told reporters on the condition of anonymity.

“What the Fed does should be ratified by the Treasury and ultimately by the Congress,” Feldstein said. “If the Congress is telling us right now, ‘No, we don’t want to provide that money to the auto companies,’ then surely the Fed shouldn’t be providing it car insurance.”

Bernanke said in the letter to Dodd that the central bank can only lend in emergency circumstances when the financing can “be secured to its satisfaction.” It’s “unclear” whether the three U.S. automakers could “meet this requirement.”

New Policy Realms

“Even if the companies have sufficient collateral, lending to an auto manufacturing company would represent a marked departure from that policy, and would take us into distinctly new realms of policymaking,” Bernanke said. “In particular, it would raise the question as to whether the Federal Reserve should be involved in industrial policy, which has traditionally been outside the range of our responsibilities.”

The “critical unknown” in the automakers’ plans is “their ability to develop and produce vehicles that the public wants to buy,” Bernanke said.

The comments represent Bernanke’s first public remarks on whether the Fed would lend to the beleaguered industry. Two regional Fed-bank chiefs said last week that the issue was best left to Congress.

The letter also refines Bernanke’s position on the rescue of individual companies following criticism by economists and investors in recent months that his approach was inconsistent toward Bear Stearns, Lehman and AIG.

Tools Available

“In the absence of an appropriate, comprehensive legal or regulatory framework, the Federal Reserve and the Treasury dealt with the cases of Bear Stearns and AIG using the tools available,” Bernanke said in a Dec. 1 speech. Lehman didn’t have enough collateral, making its collapse “unavoidable,” he said.

After the failure of Lehman jolted credit markets, Congress passed the $700 billion Troubled Asset Relief Program on Oct. 3, authorizing Treasury to inject capital into banks. Under the Nov. 23 rescue of Citigroup Inc., the Fed agreed to backstop a $306 billion pool of distressed assets after the bank, the Treasury and the Federal Deposit Insurance Corp. assumed initial losses.

“We now have tools to address any similar situation that might arise in the future,” Bernanke said in his speech last week.

The Fed’s decisions during the past year to support financial firms and short-term debt markets were aimed at ensuring financial stability and supporting the economy, Bernanke said in the speech.

While the automakers have been affected by the credit crunch, it’s “difficult to assess” the broader consequences of one or more of the carmakers becoming insolvent, he said.

Even so, Bernanke urged lawmakers to consider alternatives to direct aid, such as an “orderly bankruptcy reorganization with government aid, and government assisted mergers.”

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European Central Bank council member Ewald Nowotny said the bank is in a wait-and-see mode, signaling it won’t necessarily cut interest rates again next month.

“The situation is open,” Nowotny said in an interview in Wuerzburg, Germany, late on Dec. 5. “We’ll observe how things are working, what’s happening, and then we’ll see. The ECB certainly doesn’t want to be pressured by expectations.”

Investors are betting the deepening economic downturn will prompt the ECB to cut its benchmark rate by a further 50 basis points at its next meeting on Jan. 15, Eonia forward contracts show. The ECB lowered the rate by 75 points to 2.5 percent last week, the biggest reduction in its ten-year history. Still, President Jean-Claude Trichet refused to be drawn on whether it would lower borrowing costs again.

“We’ve taken this step, which was a relatively big one for the ECB, and we’ll monitor further developments,” said Nowotny, who heads Austria’s central bank. “I favor a steady-hand policy. Having said that, one should always retain the flexibility to react to new developments. There’s certainly room for maneuver if the future economic development is significantly weaker” than expected.

“The remarks point to a pause in January,” said Juergen Michels, an economist at Citigroup Inc. in London. “However, the ECB will cut rates again in February as the bank’s view on economic growth next year will turn out to be too optimistic.”

Downside Risks

The ECB last week predicted the economy will shrink about 0.5 percent next year, which would be its first full-year contraction since 1993. The 15-nation euro region is already in recession after the global financial crisis pushed up lending costs and damped demand for European exports.

“To my mind, the downside risks are probably bigger than the upside risks,” said Nowotny, 64. Still, “the ECB is rather cautious with interest-rate cuts and doesn’t want to commit hastily to anything.” Asked if the bank is in a wait-and-see mode, Nowotny said “yes.”

While the ECB expects inflation to drop below its 2 percent limit next year and stay there through 2010, it hasn’t achieved its price-stability goal since 1999. The ECB raised rates as recently has July, citing the threat of a wage-price spiral.

Trichet said last week he wants to avoid “being trapped” at interest-rate levels that are “too low fast pay day loans.”

Global Rate Cuts

The U.S. Federal Reserve has reduced its key rate by 325 points this year to 1 percent, and the Bank of England has lopped 2.5 percentage points off borrowing costs since Nov. 6, taking its main rate to 2 percent.

The ECB has lowered rates by 175 basis points since early October and flooded the banking system with additional liquidity. Nowotny suggested policy makers want to take stock before committing to further steps.

“There’s uncertainty regarding the extent to which the measures taken this quarter are starting to have an impact,” he said. “We’re in uncharted waters but we see several indications that the situation is normalizing. Money-market rates are declining, they’re moving to the right direction, even though only slowly.”

Nowotny said the ECB may look at ways to make the use of the bank’s deposit facility “less attractive” to commercial banks. Overnight deposits with the central bank have boomed as financial institutions choose to park money with the ECB rather than risk lending to others at a better rate.

Banks deposited 250.5 billion euros ($322 billion) on Dec. 5, the ECB said today. In the year to Sept. 15, deposits with the ECB averaged just 534 million euros a day.

‘More Clarity’

“If this development continues and the deposit facility continues to be used exceptionally, we’ll have to look at it,” Nowotny said. The interest-rate corridor “mustn’t necessarily be symmetrical. But first of all, we have to see how things evolve after the interest-rate cut.”

Lending between banks ran dry after Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, shattering confidence and sending borrowing costs to records. The ECB has provided banks with unlimited cash in its weekly refinancing operations to rebuild confidence in the market and revive lending.

“After the closing of the balance sheets this year we’ll hopefully have more clarity and therefore more certainty,” Nowotny said. “The ECB has acted in a very expansionary way and against this background it’s wrong to assess the ECB’s policy as restrictive.”

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