RPT-UPDATE 2-Nishimura: BOJ shouldn't wait long to raise rates

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By Leika Kihara

TOKYO, July 3 (Reuters) - The Bank of Japan should not wait too long to raise interest rates, with the nation's economic conditions favourable and prices clearly showing an upward trend, central bank board member Kiyohiko Nishimura said.

But he said the adjustment of monetary policy cannot be prescheduled or come at some fixed interval, sticking to the BOJ's official line that it will adjust rates gradually in line with improvements in the economy and prices.

"To stand pat (on policy) for a long period of time is not a prudent strategy" since accelerated economic activity could cause sharp economic swings ahead and require large policy adjustments, Nishimura said in a speech at a seminar in Washington on Monday.

But the timing of policy adjustment should be in line with Japan's general economic improvement, which does not follow a fixed schedule, he said.

Nishimura also pointed to the sizeable impact that Japanese retail investors have on the foreign exchange market, with the stable outflow of their funds partly offsetting speculative trades and pushing down volatility in dollar-yen moves.

The seminar was closed to the media, but the BOJ made copies of the speech available in Tokyo on Tuesday.

The remarks did not move financial markets much as they did little to alter the dominant market view that the BOJ will raise rates as early as August.

But some market traders took then as a warning shot against betting too much on the chance of an August rate rise.

"In financial markets, there are some views that the next rate hike will take place in August because it will be six months since the previous hike in February," said Susumu Kato, chief economist at Calyon.

"I think Nishimura's comment that there is not preset schedule for future policy moves was a warning on that view." The BOJ has kept monetary policy on hold since raising its key policy rate to a decade-high 0.5 percent in February, which was the first rate rise since July last year.

Swap contracts on the overnight call rate MIRS6 showed markets see a 74 percent chance of a rate hike in August and just a 12.5 percent probability at next week's policy meeting.

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Nishimura said "slow but steady upward pressure" on prices is clearly being felt in many markets for goods and services, which reflects Japan's moderate but steady economic recovery.

But he said there is "greater uncertainty than ever" on how the effect of monetary policy is transmitted into the economy, which warrants the BOJ to take a pragmatic approach by adjusting rates flexibly in line with economic and price developments.

Nishimura said currency market volatility has decreased with the growing presence of Japanese households, who have actively shifted their funds abroad in search of higher returns.

But Nishimura warned that a sudden change in these retail investors' behaviour could shift the direction and magnitude of trading in foreign exchange markets.

The remarks tracked those of BOJ Governor Toshihiko Fukui, who has said the interest rate gap between Japan and other countries has led an outflow of funds from Japan, and that the BOJ needs to stay on guard against a sharp unwinding of such trades.

The yen has been weak partly because of carry trades, in which investors use a low-yielding currency like the yen as a cheap source of funds to buy higher-yielding assets.

Japan is currently enjoying its longest period of expansion in the postwar era, and the BOJ's tankan survey showed on Monday that companies remain optimistic about business conditions.

Government officials stuck to their stance on monetary policy, with Finance Minister Koji Omi and Economics Minister Hiroko Ota both repeating on Tuesday that it was up to the BOJ to decide on monetary policy.

To view the full text of Nishimura's speech, go to the Bank of Japan web site at: here

(Additional reporting by Yuzo Saeki and Tetsushi Kajimoto)

((Editing by Mike Miller; Reuters Messaging: leika.kihara.reuters.com@reuters.net; +81-3-3432-8027; leika.kihara@reuters.com)) Keywords: JAPAN BOJ/

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