By Chris Oliver, MarketWatch HONG KONG (MarketWatch) -- The Bank of Japan's policy board voted unanimously Tuesday to hold its main interest rate unchanged, saying that economic growth is likely to be sluggish for some time as the fallout from the credit crunch dampens overseas consumption. "Strains in global financial markets have intensified in the wake of failures and rescues of U.S. and European financial institutions, and there are downside risks to the global economy," the Bank of Japan said in a statement published on its Website after its two-day meeting ended Tuesday. The central bank repeated the phrase from its last monthly statement that Japan's economy had been sluggish against a backdrop of high energy and materials prices. But it added that growth would continue on a tepid track as a "slowdown in overseas economies becomes more evident." "The statement was still hawkish; that means they don't have any intention to cut rates at the moment," said J.P. Morgan Chase & Co. senior Japan economist Masamichi Adachi. "It's very backward-looking; they are still mentioning inflation risks and they are still saying that the global recession is just a risk factor, not a likely scenario." The decision to hold its main interest rate at 0.5% followed a near simultaneous decision by Australia's Reserve Bank Tuesday to cut its benchmark rate by one percentage point, to 6%. Japan's benchmark Nikkei 225 index traded little changed from its midday level following the BOJ decision, ending the session near a five-year low of 10,155.90, or 3% lower. Speaking at a post-rate-meeting news conference, BOJ Gov. Masaaki Shirakawa said central banks should formulate policy based on local economic conditions, seeming to suggest he did not support coordinated interest rate cuts to tackle the crisis. A united policy approach "means that each country does something that it doesn't want to do, so in this light, it's undesirable to do something that is not in line with each countries' conditions," Shirakawa told reporters. "Each country should make monetary policy according to its price and economic conditions." Observers said the BOJ was understandably reluctant to cut rates, given that its base rate is already the lowest among industrialized nations. Japanese press reports suggested the BOJ might lower the Lombard rate for collateralized short-term loans to banks if conditions get any worse, although no direct mention was made of this facility in any of the BOJ's communiqués Tuesday. "Without any evidence of [an] extraordinary situation within Japan, the [central] bank has a very difficult situation to explain why they have to cut the rate," said J.P. Morgan's Adachi. He noted Japan's real exchange rates were already negative. In its earlier statement, the BOJ reiterated concerns that keeping rates at a low level for too long could "lead to swings in economic activity and prices" that would damage the economy in the long run. "It is necessary to be mindful of upside risks due to changes in the inflation expectations of households and the price-setting behavior of firms," the BoJ said. Inflation as measured by the consumer-price index remained at 2.5%, its highest level since the early 1990s, but is expected to gradually moderate after some months, the BOJ said. The BOJ also noted that "downside risks to the economy demand attention," but as yet, it said, the global financial crisis hasn't much affected production capacity or labor markets. The statements appeared to contradict those made by Gov. Shirakawa in September, to the effect that he saw little chance the U.S. banking crisis hurting Japan's economy, while stressing that Japan's financial markets remained stable. The quarterly Tankan survey of business sentiment, released last week, showed Japan's biggest corporations had turned negative for the first time in five years amid concerns about slumping global demand and as high commodity prices strain profit margins. The Tankan's headline diffusion index, which subtracts pessimists from optimists, came in worse than expected, with large manufacturers falling to minus 3 from 5 in June, while large non-manufacturers fell to 1 from 10. It was the first negative outlook from large manufacturers since the fiscal third quarter of 2003. Other data released last week showed Japan's jobless rate climbing to a two-year high of 4.2% in August, up 0.2 percentage point from July. Industrial output fell 3.5% in August from the preceding month, while capital-goods shipments, excluding transport equipment, fell 3.8% in August on month. Household spending was down 4% in August from a year ago.

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