Morgan Stanley Says Japan Recession to Deepen, Rate Cut Likely

By Jason Clenfield

Oct. 24 (Bloomberg) -- Japan's recession may intensify this quarter and increasing turmoil in financial markets is making it more likely the central bank will cut interest rates, according to Morgan Stanley.

``Recessionary momentum should climax in the October- December quarter,'' as production and business confidence deteriorate, Takehiro Sato, Morgan Stanley's chief Japan economist in Tokyo, wrote in a report today. ``Conditions are falling into place for a rate cut.''

The global credit crisis and a deteriorating outlook for exports caused the Nikkei 225 Stock Average to plunge to the lowest level since 2003 today. The yen's rise to a 13-year high against the dollar is also eroding exporters' profitability at a time when they are already suffering from weaker demand.

Sato said he expects the Bank of Japan to lower its key overnight lending rate from 0.5 percent in the first quarter of 2009, adding that ``but the chances of this arriving in October- December quarter are increasing.''

Investors see a 26 percent chance the central bank will lower the key rate to 0.25 percent by year-end, up from 3 percent a month ago, according to calculations by JPMorgan Chase & Co. using overnight interest-rate swaps.

Japan's economy may begin to improve as falling oil prices alleviate cost pressures for businesses and consumers and the central bank's provision of liquidity helps to ease tension in credit markets, Sato said. Government plans for income-tax cuts and measures to aid small and medium-sized businesses may also spur a recovery, he said.

To contact the reporter on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net