September 2, 2008 / 4:05 AM / 11 years ago

UPDATE 3-BOJ chief says global slowdown a needed adjustment

(For more stories on the Japanese economy click [ID:nECONJP]) (Adds comments)

By Hideyuki Sano

NAGOYA, Japan, Sept 2 (Reuters) - A slowdown in the world economy is a part of necessary adjustment to achieve sustainable growth and stability in resource prices in the future, Bank of Japan Governor Masaaki Shirakawa said on Tuesday.

Once the world’s economy has gone through such a process, the Japanese economy will return to a moderate growth path from the current stagnation, Shirakawa said.

“The world’s economy is in a transitional phase to more sustainable growth. Although it’s painful to every country ... a certain pace of adjustment in the world economy seems necessary,” he told business leaders in Nagoya, central Japan.

Financial markets showed a muted response to his remarks as they did little to alter dominant market views that the BOJ will neither raise nor cut interest rates from the current 0.5 percent for the rest of this year or even longer.

Shirakawa also said the central bank will watch for fallout on financial markets from Japanese Prime Minister Yasuo Fukuda’s sudden resignation announcement late on Monday.

Japan began searching for a new prime minister after Fukuda became the second leader to abruptly resign in less than a year, threatening a further policy vacuum. (For more stories on Fukuda’s resignation click [ID:nT114525])

Japanese share prices [.T] .N225 fell to a five-month low, mainly on weakness in Asian shares, but some said the political mess did not help market sentiment. [.N]

“Given today’s falls in share prices, Shirakawa may be worried that Fukuda’s resignation, coupled with weak economic fundamentals, could weigh on share prices,” said Seiji Shiraishi, chief economist at HSBC Securities.

Japan’s economy shrank in the second quarter as weaker U.S. and European export markets hit factories, and consumer sentiment wilted on rising food and fuel costs.

Last month the BOJ delivered a bleak assessment of Japan’s economy, calling it “sluggish” — a word it has not used since the Asian financial crisis of 1997-1998.

Most economy watchers, including government officials, see Japan as either heading into a recession or already in one, although they do not expect a sharp downturn as seen in 1998 or 2001.

Despite that, a BOJ rate cut is seen as very unlikely as prices are rising, unlike a decade ago when Japan was entering deflation.

Core consumer inflation accelerated to a decade-high of 2.4 percent in July, nearly five times the BOJ’s policy target rate of 0.50 percent.

Shirakawa said core consumer price inflation was likely to remain high, departing from his earlier assessment that price rises will accelerate further, possibly suggesting he sees inflation peaking in the near term.

The BOJ chief also said hefty rises in commodities and energy prices have not led to broad-based price increases.

Yet he also said a prolonged period of easy monetary policy can lead to excessive economic activities, citing Japan’s asset bubble from the late 1980s to the early 1990s.

“We should keep in mind that an excessively accommodative monetary policy often causes large swings in the economy after a certain time lag,” Shirakawa said.

“The subprime problems and the rise in oil prices have complex origins but neither could have occurred without the continuation of high growth in the world’s economy and a long period of easy monetary policy.”

Kyohei Morita, chief economist at Barclays Capital Japan, said Shirakawa will continue to face a balancing act between the need to deal with both downside and upside risks in the near term and to watch long-term side effects of keeping interest rates low for too long.

“Unless he decides to put more emphasis on one of those risks, his comments won’t send any new message to markets,” Morita said.

Shirakawa said history showed that a deterioration in the fiscal balance could cause problems.

“We are very interested in long-term interest rates. Japan’s long-term interest rate is around 1.5 percent now. That’s because market players do not expect inflation. If they think only inflation can solve Japan’s debt problems, rates will rise,” Shirakawa said said in a question and answer session after a speech to academics.

His comments came as speculation rises that Taro Aso, a leading candidate to succeed Fukuda, might increase fiscal spending sharply to bolster the economy. [nT120820] (Editing by Michael Watson)

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