Loan demand from firms and households jumped in the first quarter, adding to the evidence that the Japanese economy is on the path of recovery, according to Senior Loan Officer Survey (SLOS).

The SLOS reported by the Bank of Japan (BoJ), which is based on responses from the 50 largest banks, showed that while loan demand for large and small sized firms increased in the first quarter, it fell for medium-sized firms. Moreover, the demand for loans from local governments and households increased in the period.

In addition, the balance for loan demand from non-manufacturers increased much higher than that for manufacturers. This was an indication that manufacturers in particular are struggling with the strength of the yen, softening global demand and with adjusting to the higher costs and lower security of power supply.

This report comes when the Japanese economy looks set to return to growth in the first quarter after contracting in four of the last five quarters. The economy should continue to expand over the rest of the year as reconstruction-related expenditure drives the GDP. The International Monetary Fund upgraded its forecast on Japan to 2 percent from its earlier 1.7 percent projection.

It is also expected that the BoJ will resort to additional monetary easing to meet its 1 percent inflation target. BoJ Governor Masaaki Shirakawa has reiterated that the central bank will pursue powerful monetary easing to pull the country out of deflation.

Aside from the boost from reconstruction spending, which largely reflects the replacement of lost assets, economic fundamentals are relatively weak, although they are on an improving trend. According to the March Tankan survey, business sentiment is lackluster and firms are downbeat about the prospects for an improvement before the second half of the year.

Meanwhile, the central bank is under mounting political pressure to expand its Asset Purchase Program following the apparent success of its February's 10 trillion yen ($122 billion) extension. However, much of the benefit from this was because the BoJ took the markets by surprise with a larger and earlier increase than expected. So it is highly likely that if the BoJ were to extend the APP again this month it is unlikely to be meet similar success.

Consumer sentiment is gradually improving but remains fragile. Supported by government subsidies on purchases of fuel efficient cars spending on automobiles has increased to its highest level in a decade. However, the spending is likely to fall back sharply when the subsidy expires.