BOJ May Signal Worsening Economy Warrants Keeping Rate at 0.5%

By Mayumi Otsuma
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Aug. 19 (Bloomberg) -- The Bank of Japan will probably say today that it's more pessimistic about the economic outlook, signaling it will keep interest rates at the lowest level among industrial nations.

The world's second-largest economy shrank last quarter, putting it on the brink of the first recession in six years. Governor Masaaki Shirakawa's central bank may cut its economic assessment for the second straight month, acknowledging that threats to growth outweigh decade-high inflation as its chief concern, according to Izuru Kato.

``The economy is deteriorating at a faster pace than the bank had judged last month,'' said Kato, chief market economist at Totan Research Co. in Tokyo. ``The Bank of Japan has no other choice but to put more weight on economic growth.''

The central bank will probably say the economy is ``stagnating'' after describing it as ``slowing further'' in July, said Takehiro Sato, chief Japan economist at Morgan Stanley in Tokyo. Since the board met last month, reports showed exports, factory production and household spending all declined in June and the unemployment rate increased to 4.1 percent.

Analysts say any downgrade in the bank's view is unlikely to herald a reduction in the benchmark overnight lending rate from 0.5 percent because Shirakawa has said he expects the economy to resume a ``moderate expansion.''

`Little Room'

``The chance is slim that the assessment would prompt the bank to look for a rate cut,'' said Morgan Stanley's Sato. At 0.5 percent ``there is little room for policy maneuvering.''

Japan's overnight rate is the lowest among the 30 members of the Paris-based Organization for Economic Cooperation and Development.

The central bank will keep the key rate on hold today, according to all 32 economists surveyed by Bloomberg News. The most recent increase was in February 2007.

The bank will probably announce the decision, along with a statement explaining the reasons for its judgment, by early this afternoon. Shirakawa will speak at a press conference in Tokyo at 3:30 p.m.

Gross domestic product fell at an annual 2.4 percent pace in the second quarter, as higher prices deterred consumer spending and a global slowdown caused a drop in exports. In April, the bank shelved a policy of raising rates, and analysts say borrowing costs will stay unchanged until next year at least.

Of 26 economists who gave predictions through June, 21 said there will be no move by then. Four estimated higher rates and one forecast a cut. Investors see a 25 percent chance of a reduction by March, according to calculations by JPMorgan Chase & Co. using overnight swaps.

`Wait and See'

``The period the Bank of Japan has to adopt a wait-and-see stance is being prolonged further,'' said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo. ``It's become difficult to raise rates even by the end of 2009.''

Japan's inflation is confined to imported fuel and foods, eroding profits and discouraging companies from increasing wages and investment. Shirakawa said last month that he has yet to see price increases spreading from oil and commodities to other goods and services.

``There have been few signs of wage-price spirals in Japan, and the bank will probably put borrowing costs on hold at least until the last quarter of 2009,'' said Kato at Totan Research.

Consumer prices excluding fresh food climbed 1.9 percent in June from a year earlier, the fastest pace in a decade. Prices businesses pay for fuel and materials surged 7.1 percent in July, the most since the wake of the second oil crisis 27 years ago.

Better Prepared

Japan may be better equipped to recover from the current downturn than in the three recessions since 1990 because companies have shed excess workers, factories and debt, according to economists. Any recession will be ``mild'' and Shirakawa is wary that keeping credit loose may eventually stimulate the economy too much, said Tomoko Fujii.

``Despite the recession, the BOJ will probably be reluctant to cut rates in view of potentially adverse future side effects of too much monetary stimulus,'' said Fujii, head of economics and strategy at Bank of America N.A. in Tokyo. Japan ``should be able to enter a modest recovery phase in early 2009.''

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