The Bank of Japan left interest rates unchanged as expected on Tuesday, as fear of a U.S. recession sent stocks tumbling around the world, with the central bank poised to warn of slower growth in an economic review due out in a few hours.
The board's unanimous vote to hold rates at 0.5 percent came as Japanese stocks tumbled more than 4 percent to two-year lows with investors following others around the world in dumping stocks, while the yen hit a 2-1/2-year high against the dollar.
With markets pointing to a better-than-even chance that the Japanese central bank will cut rates by the end of the year, the focus now is on how far the central bank will go in describing downside risks in a scheduled economic review report.
Also drawing attention is how BOJ Governor Toshihiko Fukui, who has consistently said rates needed to be gradually nudged up to more normal levels, will address global risks in a news conference after the rate decision.
The BOJ could face difficulty sticking to its rate-hike bias as global stocks tumble and U.S. and European central banks focus on downside risks.
"Whether the BOJ will eventually cut rates will depend on how Japan's real economy will cope from now. Sentiment has been badly hit but economic data has been fairly firm," said Naomi Hasegawa, senior strategist at Mitsubishi UFJ Securities. "The BOJ will probably take a wait-and-see stance. Unlike in the U.S. and Europe, companies' fund-raising costs have not risen in Japan."
Japanese money markets are pricing in a nearly 60 percent chance of the BOJ cutting rates by September, up sharply from the prices seen on Monday.
The BOJ's economic review will be issued together with its monthly economic report at 3 p.m. Tokyo time, while Fukui will meet reporters at 3:30 p.m.
Governmet Watching Markets
In the economic review, the BOJ will likely signal that Japan's growth has undershot its previous forecast issued in October because of a domestic housing slump blamed on tighter building rules, BOJ sources said. The central bank may also explain in depth the increasing risks to growth.
But it is seen sticking to its long-term scenario, at least for now, that rates need to rise from current very low levels as corporate-sector strength gradually flows through to households and supports Japan's economy.
That stance may draw criticism as Japanese stocks have sunk partly on growing concern that Japan, the world's second-largest economy, may follow the United States into a recession.
Economics Minister Hiroko Ota said she expected the BOJ to make its policy decision while taking into account the current market turbulence.
"Financial markets are very unstable now," Ota told a news conference after a cabinet meeting on Tuesday. "We will watch developments carefully."
A rate hike to 0.75 percent, once considered a near certainty by the end of last year, has been stalled by mounting threats to Japan's economic outlook and slowing U.S. growth.
Cementing the view that no rate hikes are on the horizon, hawkish BOJ board member Atsushi Mizuno, who had voted for higher rates since July, fell into line with the rest of the board in December and voted to keep rates steady.
The tone of the economic review could echo that of the BOJ's monthly report for December, which said growth was slowing. That was its first downgrade in assessment in three years.
The BOJ has maintained it will raise rates gradually in line with improvements in the economy to keep it from overheating. But tame price growth and market turmoil ensuing from the U.S. subprime problem have kept it from raising rates since February last year.