The Bank of Japan kept monetary policy unchanged on Thursday even as it lowered growth forecasts and estimated the economy tipped into recession early this year, disappointing analysts who felt the grim readings after last month's earthquake called for more policy easing.

Japan's recovery from the quake would accelerate from October, the BOJ said in its twice-yearly outlook report on the economy. At the same time, it revised up economic forecasts for the year ending in March 2013 and raised its estimate for core consumer price inflation in the current fiscal year.

BOJ Governor Masaaki Shirakawa said the central bank still needed time to examine the effects on the economy of its monetary easing last month.

But he added that he was well aware of uncertainty in the outlook and stressed that the BOJ would take further action if needed.

For the time being, we need to focus on downside risks to the economy from the quake's impact, Shirakawa told a news conference after the policy meeting.

Deputy Governor Kiyohiko Nishimura surprised the markets by proposing at Thursday's meeting that the BOJ expand its asset purchases by 5 trillion yen ($61 billion). The idea was voted down but encouraged views in the markets that the bank may ease as early as in May.

Nishimura probably sees the medium- and long-term risks from the quake as bigger than other board members, said Naomi Hasegawa, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities.

The May rate review will be closely watched for whether the BOJ will ease monetary policy further. There is a possibility it may lean toward expanding the asset-buying scheme.

Not only is it unusual for the BOJ board to reject proposals from a governor or a deputy governor, the meeting also came alongside the release of a spate of bleak data.

Industrial output fell at a record monthly pace in March, Japanese household spending declined at a record annual rate and another private survey showed manufacturing activity languishing at a two-year low.

I think the BOJ's view that a rebound is expected in the autumn is reasonable as fundamentals were recovering before the March quake, said Yoshito Sakakibara, an economist at JPMorgan Chase Management in Tokyo.

But market participants are still concerned about the status of supply chains as right now it is difficult to accurately predict how much progress companies will make over the next few months.


Supply chain disruptions, power outages and damage to sentiment from a nuclear plant crisis have hit factory output and household spending.

The auto sector has been particularly badly hit, and Japan's largest companies are likely to paint a bleak picture for this year's profits when they start announcing earnings this week.

Honda Motor Co's chief financial officer said its results for the April-June quarter were likely to be very tough and the next quarter perhaps even tougher as it struggles to repair quake-damaged plant and equipment.

But the BOJ feels it acted pre-emptively on such shocks to the economy by easing policy just days after the quake.

As widely expected, the nine-member board voted unanimously on Thursday to keep the policy rate unchanged at a range of zero to 0.1 percent and held off on additional monetary easing steps.

It also announced details of a 1 trillion yen loan scheme previously unveiled for banks in the quake-hit region, saying applications for loans would be accepted until October.

In its first forecasts since the crisis, the BOJ estimated GDP growth in the year that ended in March at 2.8 percent, down from 3.3 percent forecast in January and implying the economy contracted in the two final quarters of the past fiscal year.

The central bank cut its GDP growth forecast for the current fiscal year to 0.6 percent, down from a 1.6 percent projection issued three months ago, but expects growth to accelerate to 2.9 percent in the following year as the economy heals after the quake.

As expected, and possibly owing to the upward pressure on energy prices, it forecast core consumer price inflation at 0.7 percent in the year ending in March 2012, up from 0.3 percent forecast in January.

The BOJ probably wants to take actions in accordance with the government's compilation of extra budgets. But it will take time for the government to find financial resources to fund extra budgets for the disaster, said Susumu Kato, chief economist at Credit Agricole Securities.

And considering weakness in the stock market and expected deterioration in corporate earnings, the BOJ could have announced an increase in its asset-buying program today, as the central bank will eventually have to do.


The Japanese central bank's rate review came after the U.S. Federal Reserve signaled on Wednesday that it was in no rush to scale back its support for the economy with the labor market still on the mend.

Japan is facing its worst crisis since World War Two after the 9.0 magnitude earthquake and subsequent tsunami devastated its northeast coast last month.

The BOJ eased policy days after the quake by doubling to 10 trillion yen its funds set aside for purchases of a range of financial assets. Nishimura proposed increasing that to 15 trillion yen on Thursday.

Sources familiar with the central bank's thinking say the BOJ feels there is little that monetary policy can do when supply constraints, rather than weak demand, are the main damper to growth, as is the case now.

The next trigger for monetary easing would thus be fresh evidence that supply constraints are hurting domestic demand enough for the economy to undershoot the BOJ's forecasts.

If the central bank were to ease policy again, the most likely option would be to boost the asset buying fund once more.

Industrial output may not return to where it was before the earthquake until October-December. Companies that rely heavily on the supply chain are in bad shape, said Kiichi Murashima, an economist at Citigroup Global Markets Japan.

If the drop in production leads to knock-on effects, such as companies giving up on capital expenditure, that could prompt the BOJ to move. Still, the government has a bigger role to play than the BOJ, because it must plan rebuilding of damaged areas.

The government is expected to pass an initial 4 trillion yen

($49 billion) extra budget for disaster relief in early May that will not entail fresh borrowing.

The second emergency budget for reconstruction will likely be much bigger and involve issuance of additional bonds, although political wrangling over whether to raise taxes to cover the costs may keep bond investors nervous.

Japan's outstanding public debt, at double the size of its $5 trillion economy, is the biggest among advanced economies.

Standard and Poor's on Wednesday threatened to cut Japan's sovereign credit rating again, warning that the huge cost of last month's earthquake would hurt already weak public finances.

($1 = 81.515 Japanese Yen)

(Additional reporting by Tetsushi Kajimoto, Stanley White and Kaori Kaneko; Writing by Vidya Ranganathan; Editing by Kim Coghill and Edmund Klamann)