BOJ Keeps Rates on Hold, Seen Trimming Forecasts

The Bank of Japan left its policy rate unchanged at 0.5 percent on Wednesday, as widely expected, reflecting caution among central bankers over market uncertainty and the economic fallout from U.S. subprime woes.

Markets are now focusing on the central bank's half-yearly economic and price outlook report due out later in the day, in which it will likely to cut its growth and inflation forecasts -- a move that could reinforce expectations that the next rate hike will be delayed.

The report is also seen stressing mounting downside risks for the economy -- among them slowing U.S. growth, volatile markets and a recent raft of soft Japanese data.

"I think the BOJ will maintain its main economic scenario but tone up its warning on downside risks," said Yasuhiro Onakado, chief economist at Daiwa SB Investments. "Its outlook on the U.S. economy may be a particularly cautious one."

Financial markets did not react much to the widely expected policy decision, which was made by a vote of 8-1 with board member Atsushi Mizuno the sole dissenter.

The BOJ will release its twice-yearly economic and price outlook report later in the session, and the central bank's governor, Toshihiko Fukui, will hold a news conference in the afternoon.

The BOJ is expected to reiterate in its outlook report its stance that the economy is on track for modest but sustained growth and that rates need to rise gradually from current very low levels.

But that stance is becoming increasingly tough to sell given soft Japanese consumer prices and worries that the U.S. subprime woes could dent global economic growth.

Markets now expect the BOJ to wait until March or later before raising rates. Swap contracts on the overnight call rate are pricing in less than a 20 percent chance of a BOJ rate rise by December, a 30 percent possibility for January and about a 55 percent chance for March.

The BOJ last raised its benchmark rate in February, from 0.25 percent, but it wants to raise rates further as it thinks the current low levels, if kept for too long, could distort asset distribution and overheat the economy in the long run.

Markets had thought a hike to 0.75 percent this autumn was a near certainty before the U.S. subprime shock, which prompted the Federal Reserve to slash rates last month.

The Fed may cut rates again at a rate ruling to be announced hours after the BOJ review.

Soft Japan Data

BOJ sources said the bank's nine board members were expected to cut their median economic growth forecast for this fiscal year below 2 percent, after a contraction in April-June and sharp falls in housing starts that followed tighter regulations.

In the previous report issued in April, the board's median forecast was for gross domestic product to grow 2.1 percent this fiscal year, which ends next March 31.

The report may also highlight growing downside risks from overseas developments in light of lingering uncertainty over how U.S. subprime woes would affect markets and the economy of the United States, Japan's biggest export destination.

Recent Japanese data has not given much support to the BOJ's view that tighter job conditions will push up wages, boosting personal consumption and overall price growth.

In September, core consumer prices marked the eighth straight month of year-on-year declines, the jobless rate unexpectedly rose and wage earners' cash earnings, as well as summer bonuses, fell.

But some economists say what is more important is the outlook for fiscal 2008/09. The board members' forecast for 2008/09 growth is seen left largely unchanged from the April projection of 2.1 percent.

"I think they can still make the argument that the economy is recovering and that inflation will gradually increase, which I think keeps a rate hike on the table, and not very far away," said Richard Jerram, chief economist at Macquarie Securities, Tokyo.

The median BOJ projection for this fiscal year's core consumer price index is expected to be cut to flat from the April forecast of a 0.1 percent rise. The median forecast for 2008/09 is seen unchanged at 0.5 percent.