Muto Says BOJ to Raise Rates Based on Economy, Prices

The Bank of Japan remains committed to increasing interest rates gradually as the economy extends its expansion and prices rise, Deputy Governor Toshiro Muto said.

``The pace of needed interest-rate adjustments will be determined based on improvements in the economy and price situation,'' Muto said today in a speech in Matsue, western Japan. ``We don't have any predetermined schedule.''

Bond yields have fallen this week as investors pared bets that the central bank will raise the key overnight lending rate from 0.5 percent, the lowest among major economies, next month. Governor Toshihiko Fukui said last week that the bank must become more confident about the economy and prices before raising borrowing costs.

``Fukui's comment diminished the chance of a July rate increase, and he probably wanted to suggest that an actual rate hike would come in August,'' said Masaaki Kanno, a former central bank official and now chief economist at JPMorgan Securities Japan in Tokyo.

The yield on the benchmark 10-year bond dropped 2.5 basis points to 1.895 percent as of 1:18 p.m. in Tokyo. Yields have fallen from 1.985 percent on June 13, the highest in 11 months. The yen traded at 123.35 per dollar compared with 123.36 late yesterday in New York.

Muto's comments on interest-rate policy echoed those of board members at their May 16-17 meeting, according to minutes published today. The members said rates should be raised gradually in line with developments in the economy and prices.

No Change in Tone

``There's no real reason for the BOJ to change its tone of language given that the market has already completely factored in an August rate increase,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management in Tokyo, who isn't related to the deputy governor. ``We need to see how much Muto's comments echo Fukui's remarks this afternoon when he speaks to reporters.''

Fukui said on June 15 that all nine board members agreed on the need to be more certain that spending by Japan's consumers and companies can sustain growth before raising rates.

Japanese manufacturers said they were pessimistic in the second quarter, a government survey showed today, signaling their concern that overseas demand may stall. Sentiment among large manufacturers fell to minus 2.2 points this quarter from 0.1 point in the previous three months. A negative number means pessimists outnumber optimists.

Tankan Survey

The bank will raise rates in August as long as its quarterly Tankan business confidence survey and second-quarter economic growth are solid, according to 11 of 17 economists surveyed by Bloomberg News this month.

Today's survey probably overstates pessimism and next month's Tankan could ``remain quite strong,'' said Amy Auster, head of international economics at Australia & New Zealand Banking Group Ltd.

Muto, 63, who is most likely to become governor when Fukui's five-year term expires next March, said gains in consumer prices excluding fresh food will gradually accelerate over the long term. Wages will also gradually rise as the job market becomes tighter, he said.

Still, it's hard to expect rapid acceleration of prices as companies try to hold wages amid global competition, he said. Core consumer prices fell 0.1 percent in April, a third month of declines.

Muto ``hasn't deviated very far from the official language of the Bank of Japan,'' said Auster. ``He's coming under increased scrutiny because he is probably the favored candidate for the BOJ governor next year.''

U.S. Economy

Muto said the bank is watching the risk that favorable assumptions by companies and investors about foreign-exchange rates, economic growth, financing costs and asset prices could result in the misallocation of resources and hamper economic growth. Expectations that rates will stay low regardless of the economy's strength could hurt growth in the long run, he added.

The U.S. economy will probably achieve a soft landing and growth in other regions will make up for its slowdown, Muto said.

Still, a prolonged adjustment of the U.S. housing market and slowing business investment pose a risk, he said. Home starts fell for the first time in four months in May as interest rates rose, the Commerce Department said yesterday, suggesting the worst housing recession in 16 years will persist.

Accelerating inflation in the U.S. could also roil foreign exchange rates and bond yields globally and affect the world economy, Muto added.

In Japan, information-technology companies such as makers of mobile phones and personal computers are still trimming inventories, he said, adding that the adjustment in stockpiles should be completed by the middle of the year at the earliest.

Before becoming deputy governor in March 2003, Muto spent 37 years at the Finance Ministry, where he served as head of the budget bureau and vice finance minister, the top-ranked official.

source:www.bloomberg.com