UPDATE 2-BOJ's Fukui warns of mounting downside econ risks

Reuters ^ | 02/20/08 | Yuzo Saeki

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UPDATE 2-BOJ's Fukui warns of mounting downside econ risks

Wed Feb 20, 2008 2:51am EST (Adds Fukui comments)

By Yuzo Saeki

TOKYO, Feb 20 (Reuters) - Bank of Japan Governor Toshihiko Fukui said on Wednesday downside risks to Japan's economy may heighten as global economic adjustments continue, reinforcing market views that the bank will keep rates on hold or even cut them later this year.

Fears of more credit problems at financial firms pushed down Tokyo shares by more than 3 percent on Wednesday and Fukui, whose term expires next month, signalled that investors' waning risk appetite could continue to hurt Japan's stock market.

"Japan's economy is definitely not immune to global economic and financial adjustments. We feel that (Japan) faces significant shocks on a daily basis," Fukui told the lower house financial committee.

"There is concern that Japan will come under heightened downside risks from the global economy and that problems in the financial system could become somewhat bigger," he said.

Financial markets did not react much to Fukui's remarks but the benchmark Nikkei average closed at its lowest level in a week on Wednesday after a report that KKR Financial Holdings (KFN.N: Quote, Profile, Research) had delayed repayment of billions of dollars of debt. .N225

STILL TOO UPBEAT

Many BOJ board members had shared Fukui's cautious view as early as in January, pointing out that global economic uncertainty was increasing as U.S. growth slowed, the minutes of the central bank's Jan. 21-22 policy meeting showed on Wednesday.

Still, the members said they remained vigilant on global inflation pressures and kept an upbeat outlook on Japan's exports and production on the back of firm demand.

The minutes confirmed other BOJ comments, rather than changing its policy outlook, and an analyst said board members were still too optimistic in their outlook.

"The board members seemed to be more aware than before of downside risks from the U.S. economic slowdown, but not to the extent of altering the BOJ's main economic scenario," said Hirokata Kusaba, senior economist at Mizuho Research Institute.

"Japan's economic growth in the past few years has been largely driven by export strength, and many board members clung to the view that export growth would stay firm."

The BOJ's nine-member board voted unanimously to keep its key overnight call rate target at 0.5 percent at the meeting. It also kept interest rates unchanged in the subsequent meeting last week.

GOVERNMENT TURNING PESSIMISTIC

Fukui reiterated that despite mounting downside risks, Japan's positive economic cycle, in which output growth boosts income and spending, basically remained in place.

Other BOJ board members had endorsed this view in January, saying that while global markets remained unstable, they still saw exports rising, according to the minutes.

But such optimism may not hold for long.

The government is considering lowering its assessment of Japan's economy in its February report for the first time in over a year in the face of softening exports and output, the Nikkei economic daily reported on Wednesday.

The minutes did show a few board members saying that the timing of a soft landing for the U.S. economy was uncertain, with one member saying the subprime mortgage problems were expected to linger for a considerable time.

The BOJ has said it will need to raise rates from current very low levels in tandem with improvements in the economy, to prevent the economy overheating. A return to inflation, after a long period of falling prices, also worries the central bank.

But the subprime housing crisis, sharp sell-offs in stock markets and growing concerns about a deeper slowdown in the U.S. economy have held back the BOJ and prompted market speculation that it may end up cutting rates this year.

The minutes matched an economic review document released by the BOJ at the time of the January meeting, which said Japanese growth was somewhat weaker than expected due to a prolonged slump in housing investment triggered by new building codes introduced last June. (Additional reporting by Leika Kihara; Editing by Chris Gallagher)

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