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Japan Business Mood Worsens, BOJ Muto Mum on Rates

Soft business sentiment data on Wednesday reinforced expectations that the Bank of Japan will be in no rush to raise interest rates, pushing down bond yields, while comments from BOJ Deputy Governor Toshiro Muto did little to alter the market's direction.

The business survey index of sentiment at large Japanese manufacturers in the April-June quarter fell to minus 2.2 from plus 0.1 the previous quarter, government data showed on Wednesday, indicating these firms were less confident about business conditions.

The data kept bond yields away from the multimonth highs hit last week as it heightened the view that the BOJ's closely watched tankan survey due on July 2 would come out soft and keep the central bank from raising rates later in the month.

Muto, seen as the leading candidate to succeed BOJ Governor Toshihiko Fukui when his term expires next March, did little to alter that impression when he said the bank would examine both upside and downside economic risks in guiding monetary policy, offering few clues on the timing of the next rate hike.

"The pace of future interest rate adjustments will depend on the degree of improvement in the economy and prices," Muto said in a speech to business leaders in Matsue, western Japan.

"There is no predetermined schedule" on the timing of the BOJ's next rate hike, he added, sticking to the central bank's official line on policy.

Markets did not react to Muto's remarks, but the 10-year yield was down 3 basis points to 1.895% after the business survey data was released, keeping its distance from an 11-month high of 1.985% hit last week.

"There was no surprise in what Muto said," said Seiji Adachi, a senior economist at Deutsche Securities.

"I think the BOJ will raise rates in August. The upper house election now seems to be set for July 29. The BOJ has no need to take the risk of angering the government by raising rates before that," Adachi said.

The BOJ kept its key policy rate unchanged at 0.5 percent at last week's policy meeting as widely expected by markets. Many analysts expect the central bank to raise rates in August.

The BSI measures the percentage of firms that expect the business environment to improve minus the percentage that expect it to worsen.

Muto Neutral on Policy

Muto said inflationary expectations may heighten if the economy continues to expand above its potential growth rate of 1.5% to 2.0%, thereby heightening capacity constraints and leading to labour market shortages.

But he balanced that remark by saying it is uncertain whether prices would rise much, as tough global competition keeps companies from raising wages.

While consumer price growth remains tame in the near term, the BOJ should focus on the long-term outlook for prices in raising rates as it takes a long time for the effect of monetary policy to show up in economic and price conditions, Muto said.

Muto, a former finance ministry bureaucrat, has worked closely with Fukui since he joined the central bank in 2003 and has mostly stuck to the middle ground on monetary policy, rarely straying from the bank's official line.

A Reuters poll showed on Tuesday that economists expected the BOJ's tankan, due out at 8:50 a.m. on July 2 to show business confidence among large manufacturers remaining steady in June, with their capital investment plans seen revised upward in fiscal 2007/08.

According to Wednesday's government survey, Japanese firms planned to increase capital investment by 3.3 percent in the current fiscal year to next March.

Meanwhile, minutes of the BOJ's policy meeting on May 16-17, released on Wednesday, showed that the nine board members agreed there is considerable uncertainty about the speed of future rises in consumer prices, minutes of the meeting released on Wednesday showed.

Separate government data released on Wednesday that Japan's all-industries index, which covers a broad range of economic activity including the tertiary activity index, rose 1.2% in April from the previous month.

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