Published: Monday, 10 Aug 2009 | 11:51 PM ET

Text Size

The Bank of Japan kept interest rates on hold on Tuesday and maintained its cautious view on the economy, as deepening deflation and weak corporate spending threaten its forecast for a modest economic pick-up later this year.

The BOJ said annual consumer price falls were accelerating, going further than last month, when it said only that prices were declining. 

But it said the falls were in reaction to last year's spike in oil prices and it made no mention of how weak demand was weighing on prices, suggesting that deflation was not deepening enough to prompt the BOJ into taking action.

As widely expected, the central bank kept its overnight call rate target at 0.1 percent by a unanimous vote and held off on new policy initiatives at the two-day rate review.

Markets will be listening carefully to BOJ Governor Masaaki Shirakawa's views on how weak domestic demand could affect the bank's deflation outlook and the timing of its exit from its very low interest rates.

Remarks from Shirakawa's embargoed news conference are expected to come out some time today.

Having extended just last month its unconventional steps to ease corporate funding, the board likely focused on assessing recent data to gauge whether rises in exports and output will be sustained long enough to push the economy back towards a recovery.

The BOJ issued a statement after the meeting in which it maintained its view that Japan's economy has stopped worsening and will pick up in the latter half of the fiscal year to March 2010 as government stimulus steps take effect and overseas economies recover.

But it also repeated its warning that the outlook is highly uncertain as downside risks persist for overseas economies and final demand.

Japan's economy is expected to have grown 1.0 percent in April-June after four straight quarters of contraction due to a pickup in exports and personal consumption spurred by stimulus spending at home and abroad, a Reuters poll showed.

But economists warn that any recovery will be fragile because doubts about the sustainability of end demand remain with recent output gains driven mostly by government stimulus.

Industrial output marked a record quarterly rise in April-June. But manufacturers expect core machinery orders to fall in July-September, suggesting they remain wary of expanding their production capacity despite signs of a global economic recovery.

No Exit in Sight

Core consumer prices fell a record 1.7 percent in the year to June with weakening household demand for goods playing an increasing part in pushing down prices.

More From CNBC.com

• Pros Say: Expect 5-7% Pullback — Then Growth
• Tuesday Look Ahead: Watching the Dollar
• Yoshikami: The Death of Quality?
• More Asia Pacific News

The BOJ already expects two years of deflation, so mild price falls won't push it to return to full-blown quantitative easing, which in Japan involved flooding the banking system with cash to meet a specific monetary target.

But if deflation persists longer than expected, it could delay the BOJ's exit from very low interest rates. The central bank will probably forecast deflation stretching out for three years to March 2012 when it releases its twice-yearly outlook report in October, sources told Reuters.

Analysts polled by Reuters do not expect a rate hike until early 2011.

With the global economy emerging from the worst of the financial crisis, central banks have been debating how to exit extraordinary measures they have taken to beat a credit crunch.

The Federal Reserve, which meets on Tuesday and Wednesday, will debate whether to end a scheme to buy $300 billion of longer-dated Treasuries on schedule in September.

The BOJ has cut rates to near zero and taken unconventional steps to lessen the impact of the global financial crisis, such as buying commercial paper and corporate bonds from banks.

Credit markets have been on the mend, thanks to the measures. Bank lending rose 2.1 percent in July from a year earlier, slowing further from a record gain in January, as big firms had less need to rely on banks for funding.

• Japan Jolted by 6.6 Magnitude Earthquake

Reflecting that improvement, the central bank last month extended its extraordinary funding-support measures by just three months instead of the widely expected six.

But many market players expect the central bank to keep these measures in place beyond December as a safety net for corporate finance due to uncertainty over the economic outlook.

Print

Email

Text Size