BOJ on Hold as Oil Hurts Japan Economy, Morgan Stanley, BNP Say

By Shigeki Nozawa and Kosuke Goto

July 9 (Bloomberg) -- The Bank of Japan will keep interest rates on hold because record oil and food prices are hurting the world's second-largest economy, Morgan Stanley, BNP Paribas SA and Lehman Brothers Holdings Inc. said.

Higher raw material prices reduced Japan's national income by $200 billion, or 1 percent, between 2000 and 2007, a semi- annual government report showed on June 30 in Tokyo. That was the most among major industrialized economies. Costlier raw materials have also curbed consumer spending, data from the statistics bureau show.

``The current surge in raw materials costs won't cause Japan's economy to overheat or fuel inflationary pressures,'' said Takehiro Sato, chief Japan economist in Tokyo at Morgan Stanley, the second-biggest U.S. securities firm. ``There are even possibilities of a rate cut.''

Bank of Japan Governor Masaaki Shirakawa has left interest rates unchanged at 0.5 percent since February 2007, even as consumer price increases accelerated to 1.5 percent in May, the fastest pace in a decade. Confidence among Japan's companies and consumers is falling as crude oil prices reduce the spending power of a nation that imports more than 99 percent of its oil.

Japan's benchmark interest rates should be around 3 percent, according to a monetary policy rule used by central banks to gauge the adequate level of interest rates, according to Ryutaro Kono, chief economist at BNP Paribas in Tokyo. When the effect of costlier oil on inflation and corporate profits is taken into account, the adequate rate level falls to 0.5 percent, Morgan Stanley's Sato said.

Taylor Rule

``With the economy slowing, the BOJ is not in a situation where it can hike rates,'' said Kono, who forecast the central bank will keep borrowing costs on hold until the end of 2009.

The monetary policy rule was developed by Stanford University economist John Taylor in 1993. The so-called ``Taylor Rule'' is a short-hand formula that suggests how a central bank should set interest rates if inflation or growth veers from goals. It includes, in most cases, the potential growth rates, inflation, the gap between supply and demand and business confidence.

Profits at Japanese companies fell at the fastest pace in six years in the first quarter, prompting companies to pare spending and hiring plans, government data show. Japan's wages grew at the slowest pace in five months in May, indicating households will keep reducing spending as inflation rises faster than workers' paychecks, according to data released by the Labor Ministry on July 1.

``Although Japanese people are industrious, their income doesn't go up much,'' said Kenichi Kawasaki, chief economist at Lehman Brothers Holdings Inc. in Tokyo. ``There are no prospects for BOJ rate increases'' for the time being.

To contact the reporter on this story: Shigeki Nozawa in Tokyo at snozawa1@bloomberg.net; Kosuke Goto in Tokyo at kgoto2@bloomberg.net.