The Bank of Japan raised its view of the economy for the first time in almost three years on signs that a record contraction in the first quarter represented the worst of the recession. “Economic conditions have been deteriorating, but exports and production are beginning to level out,” the bank said in a statement in Tokyo today. Previously it said the world’s second-largest economy had “deteriorated significantly.” The central bank also decided to accept foreign currency- denominated sovereign bonds as collateral to make it easier for lenders to get cash. The first upgrade in the economic assessment since July 2006 indicates Governor Masaaki Shirakawa and his board may be reluctant to further expand a program of buying corporate and government debt, even as deflation looms. “The upgrade of the economic assessment simply came as an endorsement to the recent set of data which had already signaled signs of a bottoming out,” said Izuru Kato, chief economist at Totan Research Institute Ltd. in Tokyo. Adding foreign currency-denominated debt as collateral should be taken as “one of many other tools for a rainy day,” Kato said. The yen traded at 94.15 per dollar at 2:44 p.m. from 94.23 before the announcement and close to a nine-week high of 93.87 reached earlier today. The Nikkei 225 Stock Average fell 0.7 percent, heading for a weekly loss. ‘Leveling Out’ The central bank said “the pace of deterioration in economic conditions is likely to moderate gradually, leading to a leveling out of the economy.” Industrial production and exports began to stabilize at the end of the first quarter, when gross domestic product shrank an annualized 15.2 percent, the steepest decline since records began in 1955. The policy board unanimously voted to keep the benchmark overnight lending rate at 0.1 percent today. Since cutting the rate in December, it has begun buying commercial paper and corporate bonds from lenders, helping to ease a funding squeeze for companies. Kintetsu Corp., an operator of rail and bus services in western Japan, will sell 10 billion yen ($106 million) of debt, the first sale of BBB-rated bonds in Japan since September, according to Bloomberg data. The difference between three-month commercial paper rated A1 against government financing bills of the same maturity was 11 basis points today from 141 on Dec. 16. ‘Easing of Tension’ “Financial conditions have remained tight, although there has been some easing of tension compared to some time ago,” the central bank said. It will accept bonds issued by the U.S., U.K., Germany and France in exchange for loans to lenders as part of a program to keep credit flowing in the economy. The central bank’s assessment improved even as prospects for a global recovery darken. The U.K. had the outlook on its AAA debt rating cut by Standard & Poor’s yesterday, and Treasury yields rose on speculation the U.S.’s rating may also be under threat. Treasury Secretary Timothy Geithner committed to cutting the budget deficit in an interview with Bloomberg Television. The Chinese government said today that a recovery in factory output has yet to solidify as exports falter and firms struggle with “serious” overcapacity and falling profits. Japanese Finance Minister Kaoru Yosano said this week that the GDP report signaled the “worst may be over, but efforts still need to be made to put the economy on an upward trend.” The government will also lift its economic assessment in a report on May 25, the first increase since February 2006, the Nikkei newspaper said this week, without citing sources. Hurdles Remain Japan still faces hurdles, including a swine flu outbreak and gains in the yen that threaten to exacerbate exporters’ losses. The currency has surged 4.7 percent against the dollar this month, and today climbed to the highest since March 19 after Yosano said the government isn’t considering intervening in the foreign-exchange market. “Japan’s economy will probably return to a cyclical expansionary path later this year,” said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Securities Co. in Tokyo. “But it will be an L-shaped recovery rather than a full-fledged one” as spending by consumers and businesses falters, he said. The recession, while moderating, is spreading to households as companies including Toyota Motor Corp. and Hitachi Ltd. fire workers and slash wages to minimize losses. Mid-year bonuses will plunge a record 19.4 percent this year, according to the Keidanren business lobby group. Deflation Concern The Bank of Japan may face pressure to step up its debt purchases should weakening domestic demand exacerbate a decline in prices, ushering in a return of the deflation that plagued the country for a decade until 2005. The central bank forecasts consumer prices will fall 1.5 percent this fiscal year and keep sliding even when the economy resumes growing next year. “Growing slack in the economy is increasing deflationary pressure,” said Hiromichi Shirakawa, chief economist at Credit Suisse Group AG in Tokyo and a former central bank official. “If the BOJ is seriously committed to averting deflation, the bank would have no other choice but to aggressively buy risk assets.”

Source