Bank of Japan says won't tolerate deflation

Japan's central bank said yesterday that it was vital for the world's number two economy to snap out of deflation, setting the stage for likely further action to battle falling prices.

In unusually strident remarks, the BoJ said in a statement issued after a two-day meeting that it "does not tolerate" falls in consumer prices.

"The bank recognises that it is a critical challenge for Japan's economy to overcome deflation," the statement said, adding that BoJ would "maintain the extremely accommodative financial environment".

The Bank of Japan has already slashed interest rates to just 0.1 per cent and pumped trillions of yen into the financial system to boost the economy in the face of the worst downturn in decades.

But it has been criticised by Japan's government for not doing enough to ward off the threat of another deflationary spiral as seen after the country's economic bubble burst in the early 1990s.

The bank's remarks were seen as boosting the chances of fresh steps to shore up financial markets and revive the deflation-hit economy, possibly through increased purchases of Japanese government bonds.

"We expect the bank to gradually shift to further (monetary policy) easing ahead, on an outlook that prices will stay negative for the next three years or so," said Morgan Stanley economist Takehiro Sato.

BoJ governor Masaaki Shirakawa said it was important to boost demand in the economy to tackle deflation, which hurts companies and encourages consumers to put off purchases in the hope of finding a lower price in the future.

"The central bank's role in (avoiding a) deflationary spiral is to prevent the financial market from shrinking, through offering ample funds as we've been doing," he told a news conference.

"Not only the BoJ, but also other relevant bodies have to make efforts to ease the shortage in demand," he added.

The BoJ, under pressure from the government to step up the fight against deflation, decided earlier this month to pump 10 trillion yen ($112 billion) into the financial system through a new loan facility.

Mr Shirakawa said the announcement had shown some success in lower long-term interest rates and soothing financial market worries.

With the bank forecasting several years of deflation, analysts said it is likely to maintain very low interest rates for some time yet.

The BoJ looks set to hold its key lending rate at 0.1 per cent through 2010, predicted Susumu Kato, chief economist at Calyon Credit Agricole CIB.

Japan's core consumer prices fell 2.2 per cent in October from a year earlier, marking an eighth straight month of drops.

Japan's economy returned to positive growth in this year's second quarter after a severe year-long recession.

But the government reported last week that the world's number two economy grew at a much slower rate than previously thought in the third quarter, re-igniting fears that the fledgling recovery could stall.