Bank of Japan Governor Masaaki Shirakawa said the country's economy was in a very severe state due to damage from the March earthquake, signaling that the central bank was sticking to its ultra-loose monetary policy bias.
Shirakawa repeated that the BOJ would do its utmost to beat deflation but added that any price rises needed to be driven by solid economic growth, emphasizing the need for policies to boost Japan's potential growth.
"Deflation is a very serious problem. But the more serious problem is that Japan's economic strength is gradually declining," Shirakawa told a parliamentary committee meeting on Tuesday.
Finance Minister Yoshihiko Noda told the same committee that beating deflation was a top priority for the government, even as it battles to contain the damage from the devastating earthquake.
Japan has been mired in deflation for much of the past decade but the fall in core consumer prices narrowed to a 0.1 percent year-on-year drop in March, due largely to a spike in commodity prices.
The BOJ expects core consumer prices to rise 0.7 percent in both the current fiscal year from April and the following year, due largely to rising fuel and food costs. But it has said price rises alone will not prompt it to unwind its ultra-easy policy.
The BOJ is expected to keep policy on hold this week but stress its readiness to ease further if the quake's damage to the economy proves bigger than expected.
Japan is facing its worst crisis since World War Two after the 9.0 magnitude earthquake and a deadly tsunami battered its northeast coast on March 11, leaving about 25,000 dead or missing and crippling a nuclear plant.
The world's third-largest economy is set to log three straight quarters of contraction at the end of June, sliding back into recession, a Reuters poll showed.
While the downturn is as severe as during the financial crisis, the BOJ has made a distinction between what happened then and what the economy has faced after the quake.
"The Japanese economy faced a 'demand' shock caused by the financial crisis" after U.S. investment bank Lehman Brothers collapsed in 2008, BOJ Executive Director Hiroshi Nakaso told Reuters in an interview last month.
"This time around, Japan is facing a 'supply' shock as factories over a vast area were destroyed and there is disruption in the supply chain," he said.
The BOJ has said that once supply constraints ease, the economy will recover moderately because demand for goods is still there. Unless this view comes under threat or a renewed yen spike hurts business sentiment, it is expected to hold off on easing policy further.
The government, for its part, eyes a second extra budget to fund spending for reconstruction after the quake. Prime Minister Naoto Kan has signaled that total spending could be quite big, although Japan's huge public debt limits room for additional bond issuance.
Noda said that if the government were to issue bonds to fund costs for quake reconstruction, one idea would be to do so under a separate account than for regular Japanese government bonds.
That way, the government will commit itself to coming up with a source of revenue to redeem the quake-related bonds, which would mostly likely be through a tax hike.
Japan's struggle to put a lid on the ever-rising public debt, which at double the size of the $5 trillion economy is the biggest among leading nations, has triggered rating cuts and a slew of warnings from credit rating agencies.
http://news.yahoo.com/s/nm/20110517/wl_nm/us_japan_economy_boj
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