BOJ keeps rates steady, warns of slower growth

The Bank of Japan left interest rates on hold at 0.5 percent on Tuesday as expected but downgraded its growth forecasts, warning high energy costs are slowing the world's second largest economy.


In a surprise move, the BOJ commented on the state of the economy and revised its growth and price forecasts in its rate decision statement.

"Economic growth is slowing further reflecting weaker growth in business fixed investment and private consumption against the backdrop of high energy and material prices," the BOJ said in the statement.

"With regard to risk factors, global financial markets remain unstable and there are downside risks to the U.S. and the world economy," it said, adding that global inflationary pressure was increasing.

The central bank lowered its growth forecast for the current fiscal year to next March to 1.2 percent from 1.5 percent projected in its twice-yearly outlook report in late April.

It now sees 1.5 percent growth in fiscal 2009/10, compared with 1.7 percent expansion seen in April.

But such downward revisions did not change the market's view that the BOJ will stand pat on monetary policy for a while.

"The fact that the Bank of Japan had to release revised forecasts at the mid-term review (of the semiannual outlook report) shows that its view of the economy had been quite out of touch with reality," said Kyohei Morita, chief economist at Barclays Capital.

"The new forecasts confirm our view that the Bank of Japan will neither raise nor cut rates any time soon. We're sticking to our forecast that the next 25-basis-point rate rise will come some time in the first quarter of next year."

In Tuesday's statement, the BOJ reiterated that it would conduct monetary policy flexibly while monitoring both upside and downside risks to the economy.

Swap contracts on the overnight call rate -- the BOJ's policy target -- are pricing in around 16 percent chance of a rate hike by the end of this year, unchanged from before the BOJ's rate decision.

The BOJ said that starting on Tuesday it would publish its assessments on the economy and risks at the same time with the rate decision, and that it would issue the policy board's forecast for GDP every quarter, rather than twice-yearly.

Such changes were not announced beforehand.

Inflation Prospects

As expected, the BOJ said it saw prices rising faster than it had expected in the outlook report in April, due partly to skyrocketing oil and raw material costs.

The BOJ policy board's median forecast for core CPI growth was revised up to 1.8 percent from a 1.1 percent rise in April.

Core consumer prices, which exclude fresh foods but include energy costs, rose 1.5 percent in May and are seen rising around 2 percent or above in the coming months.

More dramatically, the BOJ now sees wholesale price inflation at 4.8 percent for the current fiscal year, revised sharply up from 2.5 percent projected in April.

The corporate goods price index (CGPI) tracks trends in the wholesale prices of goods shot up to a 27-year high of 5.6 percent in June.

Masaaki Shirakawa, the bank's governor, has said the BOJ will guide policy flexibly while carefully examining various risks facing the economy -- comments many investors have taken as meaning that there will be no policy change in the near future.

Traders will be awaiting Shirakawa's post-meeting news conference, comments from which will be embargoed until some time after 4 p.m..

Worries that the Japanese economy may be slipping into a recession, or stagflation, are being fueled by growing concerns over the health of U.S. banking sector.

Japanese government bond futures price struck a two-month high while Japanese share prices shed nearly 2 percent as U.S. government's plan to support two struggling mortgage lenders, Fannie Mae and Freddie Mac , have failed to boost optimism over the U.S. economy.