BOJ Less Likely to Raise Rates as Stocks, Prices Fall (Update2)

By Mayumi Otsuma

July 27 (Bloomberg) -- The Bank of Japan is less likely to raise interest rates in August after global stocks slumped and the nation's consumer prices fell for a fifth month.

Investors see a 48 percent likelihood of a rate increase next month, down from 66 percent yesterday, according to Credit Suisse Group calculations based on the exchange of interest payments. Consumer prices excluding fresh food fell 0.1 percent in June from a year earlier, the government said in Tokyo today.

Global stocks slid on concern a worsening U.S. housing slump will slow growth in the world's biggest economy. Bank of Japan Governor Toshihiko Fukui maintained this month that prices will resume rising, though he also said policy makers must be confident economic growth will be sustained before raising rates.

``The heightened concern over systemic risk in the U.S. may make it difficult for the bank to move next month,'' said Eishi Yokoyama, an economist at AIG Global Investment Corp. in Tokyo. ``The price report won't alter the bank's expectations that prices are going to rise in coming months.''

The Nikkei 225 Stock Average slid the most in more than four months. The Dow Jones Industrial Average yesterday sank the most since February and the FTSE 100's biggest drop in four years led European declines.

Japan's retail sales unexpectedly fell 0.4 percent in June, the Trade Ministry said today, as higher taxes, lower wages and a furor over lost pension records weighed on consumer sentiment.

Weak Data

``Given today's weak CPI and retail data as well as the stock decline in the U.S., there are more factors mounting against an August rate increase,'' said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. Shirakawa, a former central bank official, said he put the chances of an August rate increase at ``less than 50 percent.''

The yen weakened to 119.12 per dollar at 12:36 p.m. in Tokyo from 118.68 in New York late yesterday. The yield on Japan's 10-year bond fell 5.5 basis points to 1.8 percent, the lowest in seven weeks. The Nikkei tumbled 2 percent.

Concern is mounting that the U.S. housing slump will spread to the rest of the economy, crimping demand in Japan's biggest export market. Sales of new homes in the U.S. fell 6.6 percent last month, the most since January, a report showed yesterday.

``Housing market data has continued to be unimpressive,'' Tadao Noda, a Bank of Japan policy board member, said in a speech yesterday. ``Some have indicated the recovery in the housing market could take more time than initially thought so we need to continue to keep a close watch on this issue.''

Key Rate

The Bank of Japan has kept the key overnight lending rate at 0.5 percent, the lowest among major economies, since February. At the Aug. 22-23 meeting, policy makers will be able to examine the impact of July 29's upper house election, second-quarter gross domestic product and data on output and consumer spending.

``The Bank of Japan is very fortunate because it still has a bit less than one month before the next board meeting,'' said Chotaro Morita, chief debt strategist at Deutsche Securities Ltd. in Tokyo. Financial markets may settle down, allowing the bank to ``pursue its goal of raising rates gradually,'' Morita said.

Industrial production rose for the first time in four months in June, a government report will probably show on July 30, according to economists. Household spending is expected to climb for a sixth month.

Japan's economy grew an annual 1.1 percent last quarter, a third of the pace of the 3.3 percent expansion in the first three months, according to the median estimate of 14 economists. The gross domestic product report is due for release Aug. 13.

Tokyo Prices

Tokyo's core prices, seen as an indicator of the nationwide consumer price index, fell 0.1 percent in July from a year ago, the statistics bureau said in today's report. The drop in prices nationwide and in the capital matched economists' expectations.

Consumer prices in Japan have failed to rise this year, after posting gains in eight months of last year. Those increases led to speculation that the economy was emerging from more than seven years of deflation that discouraged investment and consumer spending.

Nationwide core prices may fall as much as 0.2 percent in August and September because crude oil costs were near records in those months in 2006, said Takehiro Sato, chief Japan economist at Morgan Stanley in Tokyo.

Competition among mobile-phone operators is also exerting downward pressure on prices. KDDI Corp., Japan's second-biggest mobile-phone carrier, said last week that it will cut monthly fees by half, matching a move by larger rival NTT DoCoMo Inc.

Mobile Phones

Given the mobile-phone prices, the time of the next consumer-price increase ``may be delayed to December from November,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management in Tokyo.

Still, there are also budding signs of inflation, as companies gradually pass rising costs of oil and raw materials onto retail prices. Rengo Co., an Osaka-based paper maker, this week said it will raise prices of cardboard and other paper by at least 15 percent from Sept. 1 to meet higher costs.

Inflationary expectations are increasing amid a surge in gasoline and food prices, according to a central bank survey of consumers. Some 72 percent of consumers expect prices to rise this year, compared with 59 percent in the previous quarter, the bank said in the quarterly report on July 18.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

Last Updated: July 26, 2007 23:42 EDT