BOJ Says Economy Is `Sluggish,' Keeps Rate at 0.5%

By Mayumi Otsuma
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Aug. 19 (Bloomberg) -- The Bank of Japan said it became more pessimistic about the outlook for the economy and kept interest rates at the lowest level among industrial nations.

``Economic growth has been sluggish against the backdrop of high energy and materials prices and weaker growth in exports,'' Governor Masaaki Shirakawa and his six colleagues said in a statement today after leaving the key rate at 0.5 percent.

The world's second-largest economy shrank at an annual 2.4 percent pace in the second quarter, as decade-high inflation deterred spending and a global slowdown dented exports. In April, the central bank shelved a policy of raising rates, and with Japan on the verge of a recession, economists say borrowing costs are unlikely to increase until next year at the earliest.

``Now the focus is on how long the downturn will last,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. ``The economy isn't likely to recover until 2010, and rates won't rise before then.''

Financial-market instability, the U.S. and global slowdown, and rising commodity prices all pose risks to Japan's economy, the central bank said in the statement. The bank cut its assessment for the second straight month, after saying in July that the economy was ``slowing further.''

`Moderate Growth Path'

``While growth will likely remain sluggish for the time being, it is expected to return gradually onto a moderate growth path'' as commodity prices ease and the global economy recovers, the bank said.

The yen traded at 109.74 per dollar compared with 109.80 before the announcement. The yield on Japan's 10-year bond rose half a basis point to 1.445 percent. The rate decision was unanimous, and expected by all 32 economists surveyed.

Analysts don't anticipate the bank will reduce borrowing costs because Shirakawa is wary that keeping them low could stimulate the economy too much once it recovers.

``If the downside risks to the economy turn out to decrease, there will be an increased risk that prolonging the period of accommodative financial conditions will lead to swings in economic activity and prices,'' the bank said.

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.

Resume Rate Increases

``The Bank of Japan will resume seeking normalization of interest rates once the economy shows signs of a recovery,'' said Teizo Taya, a former central bank policy maker and now adviser to the Daiwa Research Institute in Tokyo. ``Still, it's hard to anticipate a hike this year or even early next year.''

Exports dropped the most since the 2001-2002 recession, last week's gross domestic product report showed, robbing Japan of the engine that drove its longest postwar expansion. The government earlier this month described the economy as ``weakening,'' language it hadn't used since 2001, after reports showed shipments abroad, factory production and household spending all fell in June and the unemployment rate increased.

The central bank last month cut its growth forecast for the year ending March to 1.2 percent from 1.5 percent, saying higher commodity prices are hurting the expansion. Policy makers may have to lower the estimate again when they publish their next outlook in October, said Masaaki Kanno, chief economist at JPMorgan Chase & Co. in Tokyo.

Growth Outlook

``It's already become difficult for the economy to expand as much as the central bank forecast last month,'' said Kanno, who used to work at the Bank of Japan.

Rising energy and raw-material costs are squeezing businesses and consumers in a country that imports almost all of its oil and 60 percent of its food.

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.

The central bank said consumer prices are ``expected to be somewhat higher over the coming months but to moderate gradually thereafter.''

So far there's little evidence that Japan's inflation is spreading from imported fuel and foods. Excluding food and energy, consumer prices rose 0.1 percent in June. The equivalent gauge in the U.S. climbed 2.5 percent last month.

``Even though Japan's inflation is surging, it remains considerably low compared with other countries','' said Ryutaro Kono, chief economist at BNP Paribas in Tokyo. ``A rate increase is just not an option.''

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