Bank of Japan Governor Toshihiko Fukui said keeping interest rates too low could encourage excessive investment and make economic growth unsustainable.
"As these very accommodative financial conditions persist, we could see a distortion in the allocation of resources in the long term," Fukui said in a speech yesterday in Nagoya, central Japan. "That could hurt the prospects for lasting growth."
Fukui's policy of gradually raising interest rates persists even as Japan's two growth engines -- exports and corporate spending -- are set to wane. Credit Suisse Group last week lowered its growth forecast for Japan to 0.9 percent from 1.1 percent for next year, the fourth cut in six weeks.
"Fukui is trying very hard to protect a dim light for raising rates," said Takehiro Sato, chief Japan economist at Morgan Stanley in Tokyo. "In reality, the economy isn't ready for another rate hike as domestic and foreign demand weaken."
Japan's five-year government bonds rose, pushing yields down as much as 4.5 basis points to 0.99 percent, the lowest in 21 months. The yen traded at 110.57 per dollar at 3:04pm from 111.24 late on Nov. 30 in New York.
Investors see only a 5 percent chance the bank will raise the benchmark overnight lending rate from 0.5 percent, the lowest among major economies, at its final meeting for this year on Dec. 19 and Dec. 20, according to Credit Suisse calculations.
Capital spending fell 1.2 percent in the third quarter from a year ago, the Finance Ministry said today. The drop wasn't steep enough for the government to revise down its economic growth estimate for the period later this week, economists say.
The world's second-largest economy expanded an annual 2.6 percent in the three months ended Sept. 30, led by exports to China and Europe. The government will use the capital spending report to revise its GDP estimate on Dec. 7.
"Given that the economy is stably growing around 2 percent and consumer prices are expected to register larger gains eventually, current interest-rate levels are relatively low," Fukui said. "But that doesn't mean we're in a hurry to raise interest rates."
Consumer prices excluding fresh food rose 0.1 percent, the first gain since December last year, a report showed last week.
"It's not as if we're keeping our foot on the gas pedal no matter what," Fukui said. "When we need to yield or step on the brakes, we will."
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