Japan's economy grew faster than expected in the third quarter, but the Bank of Japan kept interest rates on hold in the face of market turmoil that has sent both stocks and the dollar sliding.
Bank of Japan Governor Toshihiko Fukui, speaking after the BOJ kept its key policy rate unchanged at 0.5 percent for a ninth month on Tuesday, said the GDP figures reinforced the central bank's forecast for moderate growth but he added it was watching to see if global markets and the U.S. economy worsen more than expected.
The 0.6 percent growth reported for July-September, on the back of strong exports and capital spending, meant Japan averted a recession, but it did not change market expectations that the BOJ will keep rates on hold until well into next year.
"With markets so volatile and uncertainty so high, Fukui had little choice but to make cautious remarks about the outlook for Japan's economy. There's no need for him to make hawkish comments now when markets are very unstable," said Yasuhiro Onakado, chief economist at Daiwa SB Investments.
Market players now see just a 40 percent chance of the BOJ raising rates by March, swap contracts on the overnight call rate show, down from 55 percent at times last week.
Financial markets, focusing more on the global economic outlook and recent tumbles in U.S. stocks, showed limited reaction to the BOJ's decision, Fukui's comments and the growth figures for the world's second-largest economy.
GDP Tops Forecast
The GDP figure topped a consensus market forecast for 0.4 percent expansion in the July-September period, despite a sharp fall in housing investment.
The rebound in growth meant Japan avoided a recession, which is often defined as two straight quarters of contraction, after the economy shrank 0.4 percent in April-June.
Fukui said markets remained unstable and adjustments in the U.S. housing sector would continue for some time, but he added that the BOJ had factored in slower U.S. growth in the fourth quarter and still expected a soft landing there.
But he told reporters repeatedly at a press conference that the BOJ had to watch for risks to this outlook.
"We cannot rule out a case where adjustments in the U.S. housing sector and global markets become worse than expected," he said.
"If that happens, U.S. private consumption and business fixed investment may fall below expectations through negative wealth effects, the credit tightening and deterioration in business and consumer sentiment, and this may lead to further deceleration in growth of the U.S. economy."
Concerns on Subprime
The central bank last raised rates in February, and a further hike to 0.75 percent this autumn had been seen as almost a done deal before the U.S. subprime mortgage problems shook markets.
On an annualised basis, Japan's economy grew 2.6 percent, compared with a market forecast of 1.7 percent expansion and U.S. annualised growth of 3.9 percent in the same quarter.
The firm GDP figures failed to lift Tokyo shares, which extended their losing streak to an eighth session, taking them to new 15-month lows. The yen wobbled around 110 per dollar after hitting an 18-month peak near 109.13 on Monday.
As a shaky stock market reinforced doubts about how soon the BOJ will raise rates, the yield on benchmark 10-year Japanese government bonds hit a 22-month low.
A breakdown of the GDP data showed private housing investment tumbled 7.8 percent, the biggest drop in more than 10 years. This was due to tighter Japanese building rules rather than the U.S. subprime mortgage mess.
But the weak construction was offset by strong exports and private capital expenditure. Capital spending rose 1.7 percent, while external demand -- exports minus imports -- pushed up growth by 0.4 percentage point.
Personal consumption, which accounts for some 55 percent of the economy, rose a modest 0.3 percent in July-September from the previous quarter, weighed down by sluggishness in wages.