TOKYO, JAPAN - SENTIMENT among Japanese manufacturers worsened to a three-year low in February, hurt by rising raw material costs and lacklustre personal consumption, a Reuters survey showed on Monday.

Confidence among non-manufacturers also barely recovered from last month's four-year low, as many companies continued to feel the pinch from a prolonged slump in domestic housing investment, blamed on tighter building rules adopted last June.

Companies were slightly more optimistic about business conditions three months ahead.

The Reuters Tankan, a monthly survey of leading Japanese firms designed to track the Bank of Japan's quarterly tankan survey, produced an index of plus 9 for manufacturers in February, down from plus 17 in January.

It matched a low marked in February 2005, when Japan's economic growth was at a standstill, reinforcing views that the Bank of Japan will keep rates on hold at 0.5 per cent or even cut them this year on worries over the outlook.

'Raw material costs continue to rise while demand is falling on various factors, including the domestic housing slump, hurting our profits,' a chemical firm said.

The index is derived by subtracting the percentage of respondents who say business conditions are poor from the percentage who say they are good. A result greater than zero means more of those surveyed are optimistic about conditions.

Sentiment worsened broadly in sectors ranging from oil, steel and food makers to machinery firms. The index gauging confidence at electric machinery companies fell to plus 13, the lowest level since July 2005.

Japan's economy grew at an annual clip of 3.7 per cent in the last quarter of 2007, far above the meagre 0.6 per cent recorded in the United States in the same period, on strength in capital spending and exports.

But personal consumption barely rose on slow wage growth, while sharp falls in housing investment dragged down overall economic growth by 0.3 percentage point.

The index for non-manufacturers stood at plus 2, up only slightly from a four-year low of plus 1 marked in January, as worsening consumer sentiment and the housing slump hurt sectors such as retail, wholesale, real estate and construction.

'Housing demand lacks momentum with the economy showing signs of a slowdown and household income hardly rising,' a construction firm said.

The outlook index for May stood at plus 13 for manufacturers and plus 3 for non-manufacturers, signalling that companies saw business conditions improving slightly over the next three months.

But few economists are optimistic about the outlook on looming fears of a US recession, the market upheaval over the last few months and soft domestic demand at home.

Such downside risks are expected to keep the BOJ, which left rates unchanged at last week's policy review, from acting on its long-held pledge to raise rates gradually to prevent the economy from overheating in the long run.

The survey, conducted between Jan 28 and Feb 13, covers 400 firms, of which 222 made valid responses. -- REUTERS