Japan money market prices in chance of BOJ rate cut

By Naomi Tajitsu

TOKYO, Jan 11 (Reuters) - Yen money markets have begun to factor in the possibility that the Bank of Japan may cut interest rates late in the year, given the threat of recession in the U.S. and other economies.

Yen overnight index swaps JPONIBOJ=TRDT on Friday were pricing in roughly a 20 percent chance that the BOJ may cut its overnight call rate by 25 basis points by its December meeting, according to data from interdealer broker Meitan Tradition.

This marks a drastic shift from a nearly 40 percent chance of a rate rise at the start of the week, as the prospect that the Federal Reserve may continue slashing rates this year will make it extremely difficult for the Japanese central bank to lift rates later in 2008, as forecast by many economists.

Fed Chairman Ben Bernanke on Thursday said he was ready to cut the fed funds rate aggressively from 4.25 percent as the U.S. economy faces growing risks, and a possible U.S. recession this year is seen dragging on Japan's already fragile economic growth.

"Gradually, people are seeing a chance of a (BOJ) rate cut this year," said Hitomi Kimura, fixed income strategist at J.P. Morgan Securities.

"Globally, we're seeing the possibility of a recession and that would be the only case case in which it would consider a cut."

The European Central Bank held rates on Thursday, as did the Bank of England. Market participants expect a deteriorating growth outlook for the U.K. economy will result in a BOE rate cut next month, with more to come this year.

Analysts said that the shift in the BOJ rate view was driven by Bernanke's stance, along with comments from BOJ Deputy Governor Toshiro Muto on Thursday that the economy appears to be slowing down, while global economic uncertainties are weighing on growth.

"Clearly, sentiment is weak, and after Bernanke and Muto, people are getting worried," said Kimura at J.P. Morgan.

The yield on the two-year Japanese government bond JP2YTN=JBTC, which is sensitive to changes in the monetary policy outlook, slid 3.5 basis points to 0.6 percent on Friday, edging closer to the BOJ's target rate of 0.5 percent.

Despite the moves in the yen swaps market, three-month euroyen futures 2JEYv1 are factoring in a possible BOJ rate rise in 2009, and economists for the moment are forecasting a 25 basis point rate rise towards the end of 2008.