A planned merger between Nippon Steel and Sumitomo Metal Industries would create the world’s second largest steelmaker in an effort to fend off tough competition from Asian rivals and offset shrinking demand from domestic automakers.

The deal, which would likely see Japan’s top steelmaker Nippon Steel acquiring Sumitomo Metal, comes as the industry grapples with surging raw materials prices, exacerbated recently by floods in Australia, Reuters reported.

Japanese steelmakers have been particularly hard hit as domestic automakers such as Toyota and Nissan build fewer cars at home and expand in emerging markets such as India using products from local steelmakers.

They also face cut-throat competition from South Korea’s POSCO and Baoshan Iron & Steel, China’s biggest listed steelmaker, as Japanese automakers seek lower prices to weather an unfavourably strong yen.

Analysts, as well as Japanese government officials and politicians, welcomed the plans for the merger, which is subject to approval from Japan’s Fair Trade Commission (FTC).

“The new group has a chance to become very competitive in Asia,” said CLSA analyst Jeremie Capron, adding there was room for Sumitomo Metal to cut costs with the help of Nippon Steel.

“The merged company will have the best product line-up in the industry ranging from construction steel, auto steel sheets, thick plates to seamless pipes. That’s quite unique, and the No.1 company, ArcelorMittal, does not have such a product line-up.”

Nippon Steel, whose main customers include Japanese automakers, and Sumitomo Metal Industries, which is strong in seamless pipes used in the energy, construction and machinery sectors, said they aimed to merge in October 2012 but the ratio is not yet decided.

The merged company would rank second in the world, with a combined crude steel output of 47.8m tonnes last year, Sumitomo Metal Industries President Hiroshi Tomono said at a news conference in Tokyo. It will employ more than 75,000 people.

That would still be about half the production of top-ranked ArcelorMittal but place the group ahead of Baosteel. Based on 2009 crude steel production, Nippon Steel ranked fourth in the world and Sumitomo Metal placed 19th, according to the World Steel Association.

“These are two industry goliaths. The merger of these two titans of industry looks designed to exceed anything the Chinese can do,” said John Meyer, a London-based analyst at investment bank Fairfax.

“The integration…combines the production and technical skills of both companies to produce better-quality products more efficiently and more effectively. Other steel producers will struggle to compete with the new efficiencies of scale and services being offered by the joining of these titans,” he added.

Nippon Steel, with a market capitalisation $24 billion, and Sumitomo Metal, valued at $11 billion, already hold minority stakes in each other.