The Japanese economy is placed for a slowdown despite business confidence in the country's key factory sector reaching its highest level in 13 years.

The Bank of Japan's latest Tankan survey, a quarterly monitor of executive optimism, showed sentiment at large manufacturers reaching an index figure of 26, the strongest since May 1991. Analysts had forecast a figure nearer the 22 reported in the June Tankan.

Outside the factory sector confidence also improved, to 11 from nine three months ago. The report might be "an early sign of a domestic demand-led recovery rather than one simply based on exports", Masaaki Kanno, the JP Morgan chief economist, said.

Heizo Takenaka, Japan's Economics Minister said the tankan confirmed the Government's view that the economy was "recovering firmly" after a decade of stagnation and that corporate activity was "improving".

However, a Tankan figure showing that factories were not as confident in future prospects has had been hoped raised doubts among analysts about the pace of recovery.

Takehiro Sato the Morgan Stanley economist, said: "Only the headline figure was better than expected. Rather, the overall data presents the impression of weakening momentum."

The economy, which has enjoyed five successive quarters of growth and was among the top performers among major industrialised nations late last year, was not expected to fall victim to a severe downturn.

Glenn Maguire, the Asia and Australasia chief economist at Societe Generale, said: "Clearly the peak of the cycle is behind us, but any slowdown will be gradual and modest."

The Tankan helped Japanese shares close 1.5 per cent higher and prompted a brief rally in the yen against the dollar.

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