BOJ May Keep Rate at 0.5% as Rising Costs Discourage Spending

By Mayumi Otsuma

July 11 (Bloomberg) -- The Bank of Japan will probably keep interest rates on hold next week as rising energy and commodity costs erode incomes and discourage spending by businesses and households in the world's second-largest economy.

Governor Masaaki Shirakawa and his six colleagues will leave the overnight lending rate at 0.5 percent at a two-day meeting ending July 15, according to all 39 economists surveyed by Bloomberg. The rate, doubled in February 2007, is the lowest among major economies.

Shirakawa says the risk that record commodity prices discourages spending and derails growth is more pressing than tackling inflation. Consumer sentiment is at a six-year low and companies predict profits will fall for the first time in seven years.

``The Bank of Japan is being forced to focus on the economy's downside risks,'' said Kazuhiko Sano, chief strategist at Nikko Citigroup in Tokyo. ``Still, a rate cut could fan inflationary expectations and is out of the question.''

Japan's economy probably shrank last quarter on slower exports and consumer spending, the drivers of the expansion in the first quarter, according to economists surveyed by Bloomberg last month. The central bank lowered its assessment of consumer spending in all of Japan's nine regions in its quarterly regional economic report this week.

`Risk Materializing'

``Growth probably won't make the Bank of Japan's prediction,'' for the year ending March 2009, said Mamoru Yamazaki, chief Japan economist at RBS Securities in Tokyo.

Large companies expect profits to decline 7 percent in fiscal 2008, the first drop since the 2001 recession, the bank's Tankan survey showed July 1.

``A drop in corporate profits, the source for the economy's positive cycle, will definitely discourage companies from making new investment, raising wages and hiring more workers,'' said Yasunari Ueno, chief market economist at Mizuho Securities in Tokyo. ``There's no way the bank will raise rates when incomes are being eroded and domestic demand is worsening.''

Only two of 33 economists who gave predictions through December expect a rate increase this year. The remaining 31 forecast no change. The central bank shelved in April its policy calling for higher interest rates.

April Prediction

The bank will probably say next week that the economy won't expand as much as it predicted in April while consumer inflation will be faster than projected, economists said. Policy makers will review its semi-annual outlook report published in April on July 15 at 3 p.m.

``The bank may have to push back its prediction for when the economy regains momentum,'' said Seiji Shiraishi, chief economist at HSBC Securities in Tokyo.

In April, board members predicted the economy would expand 1.5 percent in the year ending March 2009 and consumer prices excluding fresh food would climb 1.1 percent. The bank doesn't typically release new forecasts in its mid-term review, only describing how the economy and prices have performed since its last semi-annual report.

Core consumer prices rose 1.5 percent in May from a year earlier. Inflation by that measure will surge to about 2.4 percent in the third quarter, said Ryutaro Kono chief economist at BNP Paribas in Tokyo. The central bank regards prices as stable when they are between zero and 2 percent.

``Even if core prices surpass the range, that would be temporary and wouldn't trigger rate action by the bank,'' Kono said.

Shirakawa will hold a news conference at 3:30 p.m.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net