Update: BOJ Shirakawa: Upside, Downside Risks Up Slightly

-- Adds Quotes, Background From 14th Paragraph -- Japan's Economy To Stay On Recovery Track Despite High Yen

TOKYO (MNI) - Bank of Japan Governor Masaaki Shirakawa said on Thursday that both upside and downside risks to Japanese economic growth have increased slightly since April, when the BOJ's board presented its medium-term projections in the semi-annual Outlook Report.

Shirakawa also said while the yen's appreciation could hurt Japanese exports in the short term, the extent may be limited thanks to the continued global economic recovery from the recession, improving Japanese corporate profits and business confidence and the stable domestic financial system.

"Both upside and downside risks factors for Japan remain the same as in April when we last listed them and they are being balanced. But they are slightly higher," he told a new conference after a two-day policy-setting meeting.

Shirakawa noted that global financial markets remain unstable and the possibility that fiscal-tightening in Europe may worsen economies in the region, which in turn may prolong the negative feedback loop between the real economy and financial market turbulence.

He also emphasized that the BOJ needed to carefully monitor developments in foreign exchange rates and stock prices and their impact on Japanese and global economic growth.

But the governor concluded that Japan's economy would continue to recover despite any impact a rising yen value would have.

"Generally speaking, the yen's rise can be a downside risk to Japanese exports in the short term while lower share prices through a decrease of asset values and worse business sentiment can have a negative impact on capital and consumer spending," he said.

"But the degree of the effects depend on various factors -- the pace of the global economic recovery, corporate sales and profits, other financial markets and financial systems.""In this regard, the global economy is recovering and as confirmed in the latest Tankan survey, business sentiment continues to improve. Also, our short-term financial and credit markets are stable and our financial intermediation functions are much more stable than in the U.S. and Europe."

Earlier today, the BOJ policy board voted unanimously to leave the target for the overnight lending rate among commercial banks unchanged at 0.1% while revising up its economic growth forecast for the current fiscal year.

The BOJ has maintained the target at 0.1% since December 2008, when it lowered it from 0.3% at the height of the global financial crisis. This rate is seen as lowest possible without hurting market functions. In light of evidence of a continued recovery in Japanese exports and production, the BOJ board upgraded its real gross domestic product median forecast for fiscal 2010 to +2.6% from the +1.8% it projected in its Outlook Report issued in April. The BOJ board provides an update to its medium-term growth and inflation outlook in January and July after the release of the Outlook Report in April and October.

"Stock prices are unstable in each of the (major) countries. Investors' risk-aversion stance is increasing amid concern over the European financial situation. Under the existing conditions, demand for yen is increasing," he said. But he downplayed imminent effects of the strong yen and the recent drop in Tokyo share prices, saying, "Despite the strong yen and weak stocks, Japan's economy is likely to be on a recovery trend.""Japanese exports and production are increasing on the back of the stronger economic growth in emerging countries. The recovery among manufacturers is filtering through to non-manufacturers, and also to households, although moderately," Shirakawa said. The governor also said Japan's consumer spending and sentiment overall is on a recovery trend even in the face of some weak indicators for the first two months of the second quarter, including a second straight year-on-year drop in household spending in May.

"The growth in sales of durable goods is slowing but private consumption as a whole has been picking up," he noted.

Automobile sales have been supported by tax breaks for buying low-emission vehicles while spending on flat-screen TVs and refrigerators has been propped up by the government's reward program for purchases of greener consumer electronics. But the effects of these stimulus measures are waning.

As for developments in China, the largest export market for Japan, Shirakawa said, "The Chinese economy continues posting high economic growth on the back of the robust domestic demand.""In addition, investment in real estate is increasing and there is concern over an overheating. But the Chinese authorities have implemented various measures, such as guiding banks to tighten lending, restricting real estate transactions and allowing the yuan to trade in a more flexible manner," he explained.

China's economic expansion, as in other emerging countries, is an upside risk to sustained growth in Japan but it can be an "eventual" downside risk, he said, referring to the possibility that the current bubble could burst and cause a slump later.

"We have to keep a close eye on the swing in the Chinese economy," said the governor.

Regarding the U.S. economy, Shirakawa said, "Exports and private consumption are increasing and capital spending is picking up. But the pace of the economic recovery is modest, compared with its own pace in the past.""The U.S. economic performance is weaker than forecast and the weakness of the recovery is due mainly to the ongoing balance-sheet adjustments," he said.

The minutes of the June 22-23 Federal Open Market Committee meeting released on Wednesday showed that Fed officials had discussed how to aid a sputtering U.S. recovery.

Fed policymakers also lowered GDP forecasts and FOMC members acknowledged that the U.S. economic outlook had "softened somewhat," with some members saying risks had shifted to downside although changes were "viewed as relatively modest and as not warranting (more) policy accommodation".

In the process of correcting overblown U.S. balance sheets, Shirakawa said, the excessive debt problems at households continue, banks remain cautious about lending to smaller firms and businesses remain cautious about hiring employees.

"Both (U.S.) housing investment and consumer confidence is lower than market forecasts," he said. But Shirakawa ruled out the possibility that the U.S. economy will fall into a deflationary spiral as its financial system remains relatively stable.

Shirakawa also said he hopes that the results of the stress tests by the European authorities due out on July 23 will contribute to stabilizing the financial system in the region.

Market players are also focused on the results of the stress tests to gauge the degree of the worsening of financial situations at European financial institutions.

The European authorities are conducting the stress tests on 91 financial institutions, whose assets account for about 65% of the total in Europe.

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