By Mayumi Otsuma and Masahiro Hidaka Oct. 24 (Bloomberg) -- Speculation the Bank of Japan will cut interest rates is growing on concern that the world's second- largest economy will suffer a prolonged recession. There is a 24 percent chance the central bank will lower the key rate to 0.25 percent from 0.5 percent by year-end, up from 3 percent a month ago, according to calculations by JPMorgan Chase & Co. using overnight interest-rate swaps. The bank didn't take part in this month's joint rate cut by counterparts from North America and Europe, saying Japan's borrowing costs are already ``very low.'' Analysts say it may have little choice in coming months as plunging stocks and a surging yen take their toll on an already weakening economy. ``With the yen advancing and stocks falling, concerns about Japan's financial system and economy are mounting,'' said Jun Fukashiro, senior fund manager at Toyota Asset Management Co. in Tokyo. ``A rate cut by the Bank of Japan seems to be unavoidable and markets are asking for it.'' Fallout from the financial turmoil will prompt Governor Masaaki Shirakawa and his colleagues to cut their growth forecasts in a twice-yearly outlook on Oct. 31, economists say. The Nikkei 225 Stock Average tumbled 25 percent this month. The yen climbed 8.7 percent against the dollar and 19 percent versus the euro, compounding exporters' woes. Shirakawa in a speech on Oct. 20 excluded reference to an eventual recovery for Japan, and analysts say a similar omission in next week's report may point to a rate reduction. Message Sent ``Some people argue that by not using that phrase the BOJ officially sent out the message that they're not in a normalization phase anymore,'' said Hitomi Kimura, a bond strategist at JPMorgan in Tokyo. ``There is a higher possibility of a rate cut in Japan.'' The government this week acknowledged Japan has probably entered its first recession in six years after the economy shrank in the second quarter and factory output, machine orders and household spending fell in August. The central bank has left its benchmark rate at 0.5 percent since raising it in February 2007. In April, Shirakawa and his board ended a bias toward increasing borrowing costs, though they have since maintained that keeping rates low for too long may overstimulate the economy and make growth unsustainable. ``The chance that the Bank of Japan will cut rates is still slim, given that there is little room for policy maneuvering,'' said Akio Makabe, a professor of economics at Shinshu University in Nagano, central Japan. ``But we can't rule out the possibility the bank will be forced to cut jointly with other central banks should global market turbulence intensify.'' Still Minority Economists predicting a rate cut are still in the minority. Of 16 surveyed by Bloomberg News, three said they expect a reduction in the year ending March 31, and one predicted a cut early in 2010. They all said the board will leave rates unchanged on Oct. 31 before releasing the outlook at 3 p.m. in Tokyo. So far the Bank of Japan's efforts toward stemming the market turmoil have focused on unlocking credit markets after banks in the U.S. and Europe stopped lending to each other following last month's collapse of Lehman Brothers Holdings Inc. Shirakawa last week said providing liquidity is the most essential contribution central banks can make to weather the turbulence. Some economists say the bank will stick to that approach because next week's report will show the policy board forecasts a recovery in the year after next. ``The Bank of Japan will maintain the status quo for the time being and will keep focusing on providing liquidity as part of international coordination,'' said Teizo Taya, a former central bank board member who now advises the Daiwa Institute of Research. ``I don't expect the bank to cut rates.'' Barely Growing The world's second-largest economy will probably expand 0.1 percent this fiscal year and 0.5 percent in the next, according to the median estimate of 16 economists surveyed. Growth will pick up to 1.5 percent in the year starting April 2010, according to 14 economists who gave predictions. ``The Bank of Japan will probably highlight that the economy will pick up in fiscal 2010 and say borrowing costs are low enough to stimulate growth,'' said Masaaki Kanno, chief economist at JPMorgan in Tokyo and a former central bank official. ``But if the yen keeps rising, stocks keep falling and the economy deteriorates further, a cut will become more likely.'' =============================================================================== CPI CPI CPI GDP GDP GDP Firm Economist FY08 FY09 FY10 FY08 FY09 FY10 ------------------------------------------------------------------------------- Median 1.7% 0.6% 0.6% 0.1% 0.5% 1.5% =============================================================================== Barclays Capital Chotaro Morita 1.7% 0.5% 0.5% 0.5% 1.6% 1.8% BNP Paribas Ryutaro Kono 1.6% 0.9% 0.8% 0.1% 0.4% 1.9% Credit Suisse Hiromichi Shirakawa 1.7% 0.0% -0.8% -0.1% 0.5% 0.0% Dai-Ichi Life Research Hideo Kumano 1.5% 0.5% 1.0% 0.2% 0.5% 1.5% Daiwa Research Teizo Taya 1.5% 1.0% 1.2% 0.0% 0.5% 1.0% Daiwa Securities SMBC Mari Iwashita 2.0% 0.9% 0.5% 0.0% 0.3% 1.3% Goldman Sachs Tetsufumi Yamakawa 1.6% 0.8% n/a 0.3% 0.9% n/a JPMorgan Securities Masaaki Kanno 1.7% 0.1% 0.5% -0.2% 0.2% 1.0% Mitsubishi UFJ Sec. BCR Yuji Shimanaka 1.8% 0.9% 1.1% 0.0% 1.0% 2.2% Mitsubishi UFJ Sec. Jun Ishii 1.5% -0.2% 0.6% 0.1% -0.1% 1.6% Mizuho Securities Yasunari Ueno 1.9% 0.6% 0.1% 0.4% 0.8% 1.5% Morgan Stanley Takehiro Sato 1.8% 0.9% n/a -0.3% -0.4% n/a Nikko Citigroup Kazuhiko Sano 1.6% 0.5% 0.2% 0.0% 0.3% 1.2% Nomura Securities Naka Matsuzawa 1.7% 0.6% 0.5% 0.1% 0.6% 1.5% Shinshu University Akio Makabe 1.8% 1.3% 1.2% 0.8% 1.0% 1.3% Totan Research Izuru Kato 1.7% 0.5% 1.0% 0.1% 0.3% 1.5% =============================================================================== To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

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