By Mayumi Otsuma and Toru Fujioka Nov. 20 (Bloomberg) -- The Bank of Japan held interest rates near zero amid mounting government pressure for it to fight deflation that could stunt the recovery from the country’s worst postwar recession. Governor Masaaki Shirakawa and his colleagues held the overnight lending rate at 0.1 percent, the central bank said in a statement today in Tokyo. They lifted their assessment of the economy, saying it’s “picking up,” hours after Deputy Prime Minister Naoto Kan warned about a rising danger of deflation. The divergence in judgment on the economic outlook indicates tensions may escalate between Prime Minister Yukio Hatoyama’s government and the central bank. Politicians may be sending signals to the Bank of Japan that it should increase its purchases of government bonds, some analysts say. “Given the bank’s independence, the government can’t ask the BOJ directly to cut rates or buy more bonds,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. in Tokyo. “That’s why it’s using this term ‘deflation’ to force the BOJ to step up its accommodative measures.” The yen traded at 88.91 per dollar at 2:01 p.m. in Tokyo, little changed from 88.88 before the announcement. The yield on Japan’s 10-year bond fell half a basis point to 1.295 percent, after touching 1.285 percent, the lowest since Oct. 9. All 22 economists surveyed by Bloomberg expected the rate decision, which was unanimous. ‘Picking Up’ “Japan’s economy is picking up mainly due to various policy measures taken at home and abroad, although the momentum of a self-sustaining recovery in domestic private demand remains weak,” the central bank said. Last month it said the world’s second-largest economy “has started to pick up.” Gross domestic product grew an annualized 4.8 percent last quarter, the fastest pace in more than two years, while a gauge of prices excluding imports tumbled the most in 51 years, a Cabinet Office report showed this week. Discounts by retailers from Aeon Co. to Fast Retailing Co. are helping push down consumer prices, which slid 2.3 percent in September, a seventh drop. The central bank said last month it expects them to keep sliding through fiscal 2011. Sustained price declines threaten to squeeze profits and wages, smothering demand in an economy that analysts say may slow in coming months as global stimulus measures are withdrawn. Deflation blighted Japan during its so-called lost decade of stagnation after an asset bubble burst in the early 1990s. ‘Sense of Crisis’ Kan said today that Japan is “in a deflationary state” and the government will tell the central bank that monetary policy “plays a significant role” in tackling falling prices. Earlier this week he signaled that the government may mention deflation in its monthly economic assessment, due for release today, for the first time in three years. His concern was echoed by other ministers today. Finance Minister Hirohisa Fujii said there’s a “sense of crisis” about falling prices. He called on the central bank to respond to the deflation threat, while acknowledging that rates are already “very low,” limiting room for further monetary policy action. Financial Services Minister Shizuka Kamei said the bank should be more aware of aligning its policies with the government when prices are falling. “The bank will aim to maintain the extremely accommodative financial environment,” today’s statement said. “The bank will provide steady support for Japan’s economy to return to a sustainable growth path with price stability.” The BOJ will keep the benchmark rate at 0.1 percent through 2010, according to 15 of 17 economists surveyed by Bloomberg News this month. Asian Inflation Japan’s price slump contrasts with the rest of Asia, where low interest rates and fiscal stimulus have heightened the risk of asset bubbles. India and South Korea will need to tighten monetary policy to tame inflation, the Organization for Economic Cooperation and Development said yesterday. The OECD said an increase in the Bank of Japan’s government bond purchases would combat deflation by adding liquidity to markets and pushing up price expectations. Increasing the monthly debt buying from the current 1.8 trillion yen ($20 billion) may also help to contain long-term interest rates as the government struggles to restrict the budget amid a slump in tax revenue. Shirakawa has said the bank’s debt purchases aren’t aimed at funding fiscal spending and propping up the bond market. Some analysts say an increase of the purchases may cause Japan’s fiscal burden, the world’s largest, to balloon and prompt investors to dump bonds, driving yields higher. “Sure, more fiscal spending by the government combined with more bond buying by the central bank may make it easier for Japan to get rid of deflation,” said Masaaki Kanno, chief economist at JPMorgan Chase & Co. in Tokyo, who used to work at the central bank. “But it’s problematic if the central bank keeps raising bond purchases without limit.” To contact the reporters on this story: Mayumi Otsuma in Tokyo motsuma@bloomberg.net; Toru Fujioka in Tokyo at tfujioka1@bloomberg.net

Source