Japan May Suffer From U.S. Woes

Bank of Japan Deputy Governor Toshiro Muto said the U.S. housing recession and financial- market turmoil could hurt Japan's economy, making it difficult to decide when to raise interest rates.

The central bank expects the economy to keep growing with stable prices, though we must examine both upside and downside risks carefully, Muto, 64, said in an interview yesterday in Tokyo. This is quite a difficult situation.

Governor Toshihiko Fukui, who Muto is favored to replace in March, this week also said the U.S. housing slump and market gyrations could become worse than expected, threatening global growth. Credit Suisse Group, Goldman Sachs Group Inc. and UBS AG this month pushed back forecasts for the next rate increase from the first quarter of next year until at least the third quarter.

Muto said policy makers are fully aware that growth in Japan would be threatened should the U.S. slowdown spread to the rest of the world. The housing crisis and banks' reluctance to lend have yet to damp spending by U.S. consumers and companies, he added.

The central bank this week held the benchmark overnight lending rate at 0.5 percent, the lowest among major economies.

Muto said expectations that borrowing costs will stay low for a long time regardless of improvements in the economy could cause fluctuations in growth and prices and encourage inefficient investment.

Risky Investments

In the past month, Fukui has also said Japan's rates need to rise to deter companies and traders from making risky investments, even as barriers mount against an increase.

Export growth slowed in September as shipments to the U.S., Japan's biggest market, fell at the fastest pace in almost four years. At home, consumer prices have yet to rise this year and household spending is being curtailed by falling wages and a deteriorating job market.

Muto rebuked criticism that the central bank is eager to raise rates hastily.

Policy makers have never said such things, he said. We have repeatedly said we'll raise interest rates in accordance with improvements in the economy and prices; we don't have any predetermined schedule.

Japan has struggled to beat deflation that emerged after an asset-price bubble burst in the early 1990s and compelled the central bank to cut interest rates to near zero percent. The bank raised the key rate for the first time in almost six years in July 2006 and doubled it to 0.5 percent in February.

Third-Quarter Growth

Recent data, including gross domestic product figures that showed the economy rebounded in the third quarter, back the bank's outlook that the expansion will be sustained, Muto said.

Japan's economy grew an annualized 2.6 percent last quarter after contracting 1.6 percent in the previous three months, as exports and consumer spending countered a drop in housing investment, the government said this week.

Muto said the severe decline in housing will eventually be reversed. The drop was caused by the enforcement of stricter rules for obtaining building permits and pent-up demand will be met later, he said. Muto forecasts economic growth will average about 2 percent over the two years through March 2009.

Japan's housing starts tumbled 44 percent in September after the government introduced the rules in response to a 2005 scandal involving faked earthquake-engineering data.

Core consumer prices, which exclude fresh food, are highly likely to enter positive territory from the end of the year or toward the beginning of next year, even if only modestly, Muto said.

Source - Bloomberg