The Bank of Japan will hold an emergency meeting on Tuesday and Governor Masaaki Shirakawa warned credit strains were driving up corporate borrowing costs at the fastest pace since Japan's financial crisis a decade ago.

The BOJ policy board will hold a meeting from 1 pm Tokyo time on Tuesday to discuss measures to help corporate finance, and Shirakawa will hold a news conference at 3:30 pm, the central bank said. 

Shirakawa, in a speech in southern Japan on Monday, gave his most downbeat assessment of the economy to date, convincing many analysts he is ready to take action to ease credit market conditions, but not necessarily an imminent interest rate cut.

"Although the level of interest rates (charged to companies) is somewhat lower than in 1998 and 1999, when corporate financing experienced a period of increased pressure, the so-called credit crunch, the pace at which these rates are rising is comparable to that in 1998 and 1999," Shirakawa said.

Economics Minister Kaoru Yosano also warned that Japan faces deflation despite planned government stimulus measures to fight the first recession in seven years.

Shirakawa said sluggishness in economic activity had increased rapidly, as shown in weak output data last week, and that had heightened the chance of Japanese annual consumer inflation briefly turning negative in the fiscal year starting next April 1.

CNBC.com

"Data released last week, such as industrial output, showed the economy in a severe state," Shirakawa told an audience in Fukuoka.

"Sluggishness in economic activity has increased rapidly. Overseas economies are experiencing the same kind of rapid change."

Although that was a more cautious view of the economy than he has expressed before, Shirakawa stressed in a news conference that further cutting the nation's already very low interest rates could cause problems in smooth functioning of money markets.

"Shirakawa has grown increasingly cautious about corporate financing markets, suggesting the BOJ wants to help facilitate funding by firms as early as possible," said Hiromichi Shirakawa, chief economist at Credit Suisse.

"Looking at recent data such as industrial output, there may be a possibility that the BOJ will cut interest rates. But I don't think that will happen by the end of this year, unless it drastically downgrades its view on the economy further."

Still, some analysts say the central bank could cut the key policy rate again by the end of the current financial year in March, if economic conditions worsen dramatically. It trimmed the rate to 0.3 percent from 0.5 percent in October.

Economics Minister Yosano was similarly downbeat. 

"I cannot tell you it will be a bright next day. The time for endurance has come," Yosano told the Financial Times in an interview published on Monday.

"We are moving to the next phase of shrinking consumption -- some call it deflation -- production going down and prices going down," the paper quoted the minister as saying, but added he also ruled out large amounts of spending to stimulate the economy.
     
Recession Deeping

Industry data showed automobile sales in Japan, excluding minivehicles, fell 27.3 percent in November from a year earlier, the largest fall for November in 39 years, putting the annual sales figure for 2008 on course to be the lowest since 1974.

That came after figures on Friday showed Japanese industrial production dropped sharply in October and manufacturers forecast record falls in coming months, prompting warnings that growing global gloom means Japan's recession will be deep and long.

The BOJ is considering easing criteria for its acceptance of corporate bonds as collateral until next April to help companies tide over the end of calendar year in December and financial year in March, when funding pressure becomes strong, NHK said.

A BOJ spokesman declined to comment on the report.

The central bank said at its last policy meeting just over a week ago that it would be more flexible in buying commercial paper and also promised to consider ways to increase the flexibility of its market operations collateralised with corporate debt.

The BOJ is coming under pressure from the money markets to take more aggressive funding steps as money market rates inch up due to mounting concerns about market tightness.

Rates on the JGB repo market have been edging back up near the 0.5 percent Lombard lending rate after falling as low as 0.4 percent in the wake of the BOJ's rate cuts on Oct. 31.

Tokyo has announced a total of 6.8 trillion yen ($71 billion) in spending on stimulus measures as it joins other major economies -- from Europe, to the United States to China -- in seeking to ease the impact of the global financial crisis on their economies.

While speculation about more steps is growing with the world's No.2 economy facing perhaps its longest recession on record, Yosano rejected increased public spending given Japan's huge public debt totalling 1-½   times gross domestic product.

"We are already deep in debt, so to create effective demand for instant pleasure would not be wise," Yosano was quoted as saying in the interview.

The credit crisis has made investors shun credit products, forcing companies to turn to bank loans as rates on the commercial paper they issue have risen steadily due to a lack of investor demand.

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