BOJ drops rate-hike bias in face of slowing growth

By Hideyuki Sano

TOKYO (Reuters) - Japan's central bank, facing the prospect of sharply weakening growth as soaring raw materials costs bite, gave up a two-year bias towards raising rates on Wednesday and warned downside risks dominated for the world's second-largest economy.

The glum outlook, delivered as the Bank of Japan decided to keep its interest rates at just 0.5 percent, the lowest among major G7 economies, helped send Japanese government bond futures soaring almost a full point.

"If we look at the prospects for 2008/09, we are putting more emphasis on downside risks than on upside risks," Governor Masaaki Shirakawa told a news conference.

For the first time in two years, the bank dropped from a half-yearly report on the economy its mantra of gradually "adjusting" Japan's low rates towards more normal levels.

The BOJ cut its growth outlook for the year to next March to 1.5 percent, from a previous 2.1 percent, and almost tripled its inflation forecast to 1.1 percent, up from 0.4 percent in its last half-yearly report in October.

The bank warned booming energy, food and other commodity costs posed risks to the economy along with turbulent markets and a faltering U.S. economy, which has curbed Japanese exports.

"Given the current situation where the outlook for economic activity and prices is highly uncertain, it is not appropriate to pre-determine the direction of future monetary policy," the BOJ said in the report.

The weakening economic outlook came as a string of new figures showed a sharp drop in Japanese industrial output and soft household spending, job vacancies and housing starts.