Bank of Japan May Raise Economic View Even After Record Plunge

(Bloomberg) -- The Bank of Japan may raise its assessment of the economy for the first time since July 2006, even after a report yesterday showed a record contraction in the first quarter.

Gross domestic product shrank at an annual 15.2 percent pace, the government said yesterday, the steepest drop since records began in 1955. That may represent the worst of the recession and Governor Masaaki Shirakawa’s board will maintain its policy at a meeting ending tomorrow, economists say.

Shirakawa said last week that a “moderate” recovery is likely as exports and production improve, indicating the central bank may be reluctant to expand its purchases of corporate and government debt. The risk is that the policy board underestimates the threat posed by price declines that could smother an economic revival.

The bank “could go much further, expanding its balance sheet more aggressively in order to boost activity and lift the economy out of deflation,” said Ben Eldred, an economist at Daiwa Securities SMBC Co. in London. “But there is no sign that it’s prepared to do so. The result is likely to be a more muted recovery and a protracted period of falling prices.”

Policy makers will hold the overnight lending rate at 0.1 percent tomorrow, according to all 24 economists surveyed by Bloomberg News. The bank may consider adding foreign currency- denominated assets to the collateral it accepts from lenders to guard against further financial-market turmoil, the Nikkei newspaper reported this week, without citing sources.

May Resume Growing

Reports in the past month suggest growth may resume this quarter. Confidence among consumers rose to a 10-month high in April. Exports increased in March from a month earlier, and factory production rose for the first time since September.

Shirakawa said last week that the bank expects the recession to “moderate gradually and the economy to start to level out towards the end of this year.” Economists anticipate the government’s 25 trillion yen ($264 billion) in stimulus measures will provide at least temporary relief.

Still, yesterday’s GDP report showed that even as exports and output begin to stabilize, the recession is spreading to households as companies fire staff and cut wages to stem losses.

While the bank is likely to raise its economic assessment, “policy makers will stay on alert against the risk that growth will fail and prices will keep falling,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo.

Two consecutive quarters of record contractions in GDP have shrunk the economy to its 2003 size and pushed it closer to the deflation that it overcame less than four years ago.

‘Worst Is Out’

“The economy has slid so far that whatever you do now, it looks good,” said Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo. “We’ve had two quarters of shrinking by 15 percent. Of course the worst is out.”

During Japan’s last tussle with deflation, consumers delayed purchases, eroding profits and forcing firms to cut wages. Shirakawa has said consumers this time around still anticipate inflation and a spiral of falling prices is unlikely.

Bank of Japan policy makers say they consider inflation to be stable at zero to 2 percent. That sets the bar too low, inviting price declines, said Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo.

“There’s going to be deflation as far as the eye can see,” Jerram said. The central bank should aim for inflation of 2 percent and make a commitment to keep buying bonds to meet the target, effectively printing money in a “permanent debt monetization,” he said.

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