BOJ Is Concerned Rising Costs May Crimp Spending, Nakamura Says

By Lily Nonomiya

June 26 (Bloomberg) -- The Bank of Japan is concerned that rising energy and raw-materials costs may force the nation's companies and consumers to spend less, policy board member Seiji Nakamura said.

``Even though capital spending and personal consumption remain solid, we need to carefully watch whether weakening of the spending mechanism will hurt domestic demand,'' Nakamura, 66, said in a speech in Asahikawa, northern Japan.

Nakamura said the central bank is also watching whether rising inflationary pressures worldwide will spread to Japan. ``Rising uncertainty'' over the economic outlook makes it inappropriate to predetermine the policy direction, he added, reinforcing that the bank has no bias toward raising or lowering the benchmark interest rate from 0.5 percent.

``Nakamura's speech indicates that unlike in the U.S. and Europe, rising commodity prices are only intensifying the risk of Japan's economic deterioration,'' said Mari Iwashita, chief market economist at Daiwa Securities SMBC Co. in Tokyo. ``There's no chance for the central bank to raise interest rates this year at least.''

The yield on Japan's five-year note fell 1.5 basis points to 1.24 percent, the lowest in three weeks. The odds that the Bank of Japan will lift borrowing costs by year-end slid to 36 percent from 50 percent at the start of the week, interest-rate swaps show, according to JPMorgan Chase & Co. calculations.

Faster Inflation

Higher prices of oil and food are spurring the fastest inflation in a decade, crimping profits and forcing companies in the world's second-largest economy to pare spending plans.

``Uncertainty concerning the outlook is rising because of trends in overseas economies, inflationary pressures resulting from surging energy and raw-materials prices, as well as volatility in global financial markets,'' Nakamura said. ``It's important to be flexible in implementing monetary policy in accordance with developments in the economy and prices.''

Only three of 34 economists surveyed by Bloomberg News this month said the bank will increase rates this year. The remaining 31 expect no change in the benchmark rate, the lowest in the industrialized world, which was last raised in February 2007.

Still, Nakamura said Japan's interest rates are lower than the inflation rate and may stimulate demand in the world's second-largest economy.

``Real short-term rates are negative and in relation to the potential growth rate, they are very low,'' Nakamura said. ``I think that this accommodative monetary environment amid such low interest-rate levels will support private demand.''

Consumer Prices

A report tomorrow will probably show that consumer prices excluding fresh food climbed 1.4 percent in May, the fastest pace in a decade. Wholesale inflation surged 4.7 percent last month, the quickest in 27 years, increasing pressure on companies to pass record commodities costs to households.

Given that food and energy costs are rising ``it is expected that gains will remain around the mid-1 percent range for some time,'' Nakamura said. ``There is a need to keep an eye on changes in consumers' inflationary expectations, companies' price-setting behavior as well as whether rising inflationary pressures overseas will spread to Japan.''

Sentiment at the nation's largest manufacturers fell at the fastest pace in four years this quarter, a government survey this week showed, and companies said they plan to cut capital outlays 0.9 percent in the year ending March 31. Data yesterday showed growth in exports slowed to 3.7 percent last month as sales to Europe fell for the first time in more than two years.

Nakamura headed MOL Ferry Co., a subsidiary of Mitsui O.S.K. Lines Ltd., before joining the policy board in April 2007.

To contact the reporter on this story: Lily Nonomiya in Asahikawa City lnonomiya@bloomberg.net