HIGHLIGHTS 3-BOJ Shirakawa: Japan economy rapidly stagnating

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FUKUOKA, Japan, Dec 1 (Reuters) - Bank of Japan Governor Masaaki Shirakawa said on Monday Japan's economy was stagnating rapidly but reiterated that further interest rate cuts could distort money market functions.

Shirakawa said financial conditions have rapidly become less accommodative, with availability of funds for Japanese firms falling sharply.

The central bank will hold an emergency policy meeting on Tuesday to discuss measures to ease credit strains.

Following are key comments by Shirakawa during his meeting with business leaders in Fukuoka, southern Japan, and at a news conference that followed:

MONETARY CONDITIONS

(From speech)

"Financial markets in Japan, which had remained stable relative to those in the United States and Europe, have also drastically changed since the bankruptcy filing by Lehman Brothers.

"Interest rates applied to funding in the market, such as issuing commercial paper and corporate bonds, are rising, reflecting growing risk aversion among investors such as investment trust companies and life insurance companies ...

"The issuing rates on corporate bonds have been rising, especially for those with low credit ratings, and issuing rates on CP, which had been creeping up since the summer, have risen rapidly since September.

"Although the level of these interest rates is somewhat lower than in 1998 and 1999, when corporate financing experienced a period of increased pressure, the so-called credit crunch, the pace at which these rates are rising is comparable to that in 1998 and 1999.

"Even with the current sharp rise in issuing rates on CP, funding rates as a whole remain broadly unchanged and remain very low relative to firms' profitability ...

"Nevertheless, corporate profits are under strong pressure ... This seems to indicate that the level of funding rates relative to profitability is becoming less accommodative ...

"With respect to the quantitative side, the availability of funds is showing marked changes ... The rate of increase in the amount outstanding of CP issued, which had been around 10 percent year-on-year since 2007 until the failure of Lehman Brothers, declined sharply thereafter owing to growing risk aversion among investors, and has recently fallen below the previous year's level.

"Furthermore, the postponement of corporate bond issuance, which had been limited to firms with low credit ratings, is spreading to firms with high credit ratings, which in the past had been able to issue bonds without difficulty.

"Under these circumstances, it seems that firms' attitudes are becoming increasingly defensive against the backdrop of the deceleration in global economic growth and the turmoil in financial markets as well as increased future uncertainty, and this is leading to a growing number of firms hoarding liquidity.