Business

Sun Jun 15 19:27:17 PDT 2008

TOKYO (Reuters) –
The Bank of Japan kept interest rates on
hold at 0.5 percent in a unanimous vote on Friday, as widely
expected, as it balanced concerns about rising inflation with a
worsening economic outlook.

While the BOJ, like other central banks, is worried about
inflation from soaring raw materials costs, it sees little need
to shift to a tightening bias for now as the economy is hardly
overheating and inflation is not spreading much beyond food and
energy prices.

Nevertheless, wholesale prices are rising nearly five times
as fast as consumer inflation, squeezing companies that have
led Japan's recent growth.

Investors are thus focusing on whether BOJ Governor Masaaki
Shirakawa will join his counterparts in the United States and
Europe in stepping up inflation warnings.

"The risk of stagflation is increasing with inflation
accelerating even as the economy weakens," said Hideo Kumano,
chief economist at Dai-ichi Life Research Institute.

"Shirakawa is faced with a difficult balancing act."

Comments by Shirakawa will be reported after a news
conference expected to end by 4:30 p.m. (0730 GMT).

Rising commodity prices have swung the main focus of global
policy-makers in recent weeks away from economic growth to the
threat of a global spike in inflation.

Federal Reserve Chairman Ben Bernanke signaled this week
that the U.S. central bank would act to strongly resist rising
inflation, while European Central Bank President Jean-Claude
Trichet said rates might rise as soon as July.

The global threat of inflation is also expected to take
centre stage at this weekend's meeting of Group of Eight
finance ministers, although measures to tackle it look elusive.

The hawkish remarks by Fed and ECB officials have
heightened market expectations that the BOJ will follow in
their footsteps and hike rates later this year, although many
economists expect no action at least until early next year.

Derivatives are pricing in about a 95 percent chance of a
Japanese rate hike by the end of this year, up from less than
half earlier in the week. They are also pricing in a roughly 65
percent chance of two rate rises to 1.0 percent over the next
year.

While the BOJ sees rising public awareness of inflation as
a risk, a rate hike would become an option only if inflation
expectations begin to feed on themselves and prices of a wide
range of goods shoot up on strong demand, BOJ sources said.

The BOJ had been working towards "normalizing" rates in
Japan, its parlance for raising the country's very low rates to
more normal levels after nearly a decade of deflation.

But the U.S. subprime housing loan crisis has forced the
central bank to take a more neutral stance lately.

GLOOMY OUTLOOK

Economists expect rising energy and food prices to push up
Japan's annual inflation, which stood at 0.9 percent in April,
to near 1.5 percent or even 2 percent by later this year.

Some within the BOJ believe there is now a bigger chance
for the rise in core consumer prices to overshoot the bank's
forecast of 1.1 percent in the fiscal year ending next March
31.

Annual wholesale inflation hit a 27-year high of 4.7
percent in May, data showed on Wednesday, with pressure on
companies from spikes in costs of materials.

Even so, inflation is less a problem in Japan than in other
parts of the world such as the euro zone, where it hit a record
3.6 percent in May.

Japanese companies are only slowly passing on rising raw
material costs in the prices of their goods as tame wage growth
keeps consumers' purse strings tight.

Weakness in the economy remains the BOJ's immediate
concern, particularly with higher raw materials costs hurting
corporate activity, the key driver of Japan's economy.

In a sign of softness in private spending, consumer
confidence sank in May to the lowest level since the end of
2001, government data showed on Friday.

(Additional reporting by Yuzo Saeki)

Source: Reuters