HIGHLIGHTS 2-BOJ's Shirakawa: More rate cuts may hurt markets

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TOKYO, Nov 21 (Reuters) - Bank of Japan Governor Masaaki Shirakawa said on Friday that global financial markets remained under great strain, hurting Japanese corporate financing, but cutting interest rates nearer zero may not help.

The central bank kept its key policy rate unchanged at 0.30 percent on Friday and tweaked its market operations to ease funding pressures towards the end of the year.

Following are key remarks from Shirakawa's news conference: MONETARY POLICY

"Japan's interest rates are already at very low levels. If we were to ensure smooth functioning of money markets, cutting rates further could cause various problems. We need to be especially aware of this point at a time like this, when financial market functions are worsening.

"As for the outlook for monetary policy, we will make an appropriate decision taking into account the economy and prices, as well as financial market developments at the time."

DEFLATION RISK (Asked about the risk of deflation in Japan, other nations:)

"There are three definitions of deflation: one that describes a state of economic worsening, another that refers to asset price falls, and one other that points to consumer price falls. I think the question was about the outlook for prices in the context of economic worsening ...

"Commodity prices have already turned down and that will likely slow inflation. As we have said in our statement about risks, there is a risk of a further slowdown in inflation. Similar developments are seen overseas, with signs of price rises slowing ...

"When prices were rising, we've always stressed the importance of looking at the knock-on effect from rising raw material prices ... Fortunately, Japan did not see any knock-on effect occuring.

"Now that raw material costs are falling, a key factor to watch is whether that would cause a knock-on effect and push down overall prices.

"Prices are determined by the balance of supply-demand, the cost of imports and people's price expectations. We will closely watch the balance of domestic supply and demand and how people's price expectations develop ...

"Japan has experienced in the past, and European and U.S. economies are experiencing now, a tough situation in which asset prices have fallen after sharp rises while debt remains. That is what happened in the past year. We are faced with the aftermath of a burst of a big bubble. Affected by this development, each nation is now facing a severe situation, which could be described as deflation.

"On whether price falls are causing any problems, I don't think there is a big danger of this happening. But I think policymakers of each country are examining their economies with the possibility of this in mind."

GLOBAL ECONOMY

"When the global economy experienced strong growth from 2004 to 2007, various imbalances accumulated and we are now seeing an unwinding of this happening.

"The global economy is expected to experience a severe adjustment for some time. Reflecting this, it will take a significant amount of time for conditions to return that will allow an economic recovery in Japan.

"It's important to take time and create a base for an economic recovery, while taking measures to ensure the economy does not fall into a deep adjustment or turmoil."

JAPAN ECONOMY

"We changed our assessment of Japanese exports to 'decreasing' from last month's peaking out. The major factor behind the change was sluggishness in the world economy ...

"Big changes in the global economy have greatly affected Japanese exports. Another big change seen in the past month was in the financial environment. Global market changes are affecting Japan's financial markets. We must keep in mind that these changes could affect the economy."

QUANTITATIVE EASING

"When financial system uncertainty is very high, supplying banks with funds helps stabilise the financial system. By contrast, trying to supply ample liquidity even after financial system uncertainty eases would hurt financial market functioning.

"The BOJ decided to implement quantitative easing in the past because it was appropriate to do so in light of economic developments at the time. As for what would be the best policy in the future, we will decide by examining economic and financial developments."

MONEY MARKETS

"In the United States and Europe, funding rates such as Libor now have a tendency to deviate sharply from policy rates, making it difficult for the effect of rate moves to appear.

"In Japan, the differentials are relatively small. This is because of our ample liquidity provision and flexible market operations." (Reporting by Leika Kihara, Yasuhiko Seki and Tetsushi Kajimoto)