UPDATE 2-BOJ's Fukui says Japan economic growth slowing

(Adds comments from BOJ's Osaka branch manager, more background)

By Leika Kihara and Hideyuki Sano

TOKYO Jan 15 (Reuters) - Bank of Japan Governor Toshihiko Fukui reiterated on Tuesday Japan's economic growth is expected to slow for some time, adding to uncertainty over whether the bank will cut or raise interest rates.

Fukui's cautious view came as Japanese stock prices fell to a 26-month low on concern the yen's rise against the dollar could hurt exporters' earnings. [.T]

"Rising raw material costs are making companies somewhat more cautious about business conditions," Fukui said in a speech to a meeting of the BOJ's regional branch managers.

"Economic growth is expected to slow for some time, although after that the economy will continue to gradually expand," he said.

Fukui also said uncertainty over global economic conditions, such as surging commodity prices and downside risks to U.S. growth, warrants close monitoring in guiding monetary policy.

The BOJ has long said it will raise rates gradually, as its current policy rate of 0.5 percent is so low it could lead to the economy's overheating in the long term.

But jittery global markets, worries of a recession in the United States and signs of softness in Japan's economy since mid-2007 have cautioned the BOJ, which last raised rates to 0.50 percent from 0.25 percent in February.

Many market traders expect the BOJ to keep interest rates on hold at its policy review next week -- and for the rest of this year.

Some economists are even pondering the outside chance of a rate cut on concerns that Japan risks following the United States into a recession.

In fact, swap contracts on the overnight call rate are pricing in about 20 percent of a rate cut by June.

The yen's rebound against the dollar to a seven-week high raised worries that profits of Japanese exporters -- the main engine of the nation's economic growth -- could be hurt.

The BOJ also downgraded its economic assessment in its quarterly report on Japanese regional economies, the first downgrade since the bank started the report in 2005.

The report came after the BOJ downgraded its economic view last month, the first such major downgrade in three years, saying growth is slowing because of a plunge in house building after tighter construction rules were introduced in June.

Masahiro Samejima, the manager of the BOJ's branch in Osaka, said rising fuel and raw material costs are one reason why wages have failed to rise, especially at small companies.

But he also said exports remained firm and companies in the region -- home to many electronic goods makers -- reported decent sales for the U.S. holiday shopping season.

Governor Fukui said the turmoil in the world's financial markets -- triggered by a fall in U.S. subprime loan-related products last year -- is having a greater impact on Japanese financial institutions than initially expected.

He added, however, that would not seriously affect the stability of Japan's financial system.