HIGHLIGHTS: BOJ's Shirakawa: economy showing signs of recovery

OSAKA, Japan (Reuters) - Bank of Japan Governor Masaaki Shirakawa said on Monday the Japanese economy is showing signs of recovery, though uncertainty over the outlook remains high.

Shirakawa's assessment of the state of the economy was brighter than the central bank's latest monthly report, in which it said the economy was leveling out.

Shirakawa made the remarks in a speech to business leaders in Osaka.

Following are key quotes from Shirakawa's speech, exchanges with business leaders and news conference.

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ECONOMY AND POLICY

(In speech)

"Looking ahead, Japan's exports are expected to continue to increase as overseas economies start recovering ...

"The bank's baseline scenario is that 'Japan's economy will start recovering from the latter half of fiscal 2009.' However, I hasten to add that the bank judges that the pace of recovery is highly likely to be only moderate.

"Given that global adjustments of balance sheets will continue, it's hard to assume a marked and rapid recovery in exports ...

"At present, Japan's economic conditions are showing some signs of recovery. At the same time, the Bank fully recognizes that the outlook is associated with great uncertainty ...

"The bank will pay attention for the time being to downside risks to economic activity and prices, and continue to do its utmost as the central bank to bring Japan's economy back to a sustainable growth path with price stability.

"In the meantime, as for the treatment of temporary measures, the bank will properly make decisions without a predetermined view on thoroughly examining the state of corporate financing and financial markets."

(In an exchange with business leaders)

"The extreme phase of the credit crunch has stopped. Inventory adjustments have made progress and various fiscal stimulus steps have been taken, all pushing up demand. The question is how the economy will perform after those positive factors fade.

"As I have said before, the BOJ is not confident about a recovery in final demand. And that's what we are referring to when we say uncertainty is high.

"This is not only about the Japanese economy but also includes the world economy. And policy makers outside Japan hold similar views."

DEFLATION

(In speech)

"From autumn this year the effects of last year's higher prices are expected to diminish gradually. Going forward, price developments will in principle be affected by the supply-demand balance of the economy as a whole.

"In that regard, if economic conditions recover in line with the projection I mentioned earlier, the supply-demand balance of the economy will improve gradually, and the year-on-year rate of decline in the CPI will likely moderate.

"However, the supply-demand balance has been deteriorating greatly, reflecting a sharp deterioration in economic conditions from the autumn of last year, and the pace of improvement in the supply-demand balance is expected to be slow, reflecting the economic outlook.

"Therefore, downward pressure on prices is likely to persist for a long period. The situation is the same in the United States and Europe, and the view is prevailing in many countries that it will take a considerable period of time for the growth rate of prices to return to a desirable level ...

"Japan's financial system has so far been generally stable, and in that regard the bank does not judge that the risk of the economy falling into a deflationary spiral has increased ...

"Various survey results and market developments suggest that expectations by firms and households for inflation in the medium to long term have so far been stable."

JAPAN ELECTION

(In news conference)

"I would like to decline to comment on the economic policies of the new government. I hope that the new government will implement appropriate policies to overcome the various challenges Japan is facing.

"The BOJ will be in close contact with the government, whoever is in power.

Asked if a Democrat government would ask the BOJ to buy more government bonds: "The purpose of monetary policy is to achieve price stability under sustainable economic growth. If there is even a slight doubt on that commitment, markets will put premiums (on government bonds) and push up long-term interest rates. We'll make judgments to avoid that."

(Reporting by Hideyuki Sano; Editing by Michael Watson and Joseph Radford)