The Bank of Japan kept monetary settings unchanged on Wednesday but cut its assessment of the economy on mounting evidence of the pain Europe's debt crisis is inflicting on global growth and Japan's recovery prospects.
Slowing exports, worsening business sentiment and soft capital spending are challenging the central bank's view that the world's third-largest economy will recover early next year.
In a sign of the growing impact from the global slowdown, Japan's exports fell at their fastest annual pace in six months in November with shipments to Asia declining on weak demand for semiconductor chips and digital cameras.
As widely expected, the BOJ kept its policy rate unchanged at a range of zero to 0.1 percent and held off on offering additional monetary stimulus, having loosened policy just two months ago with an increase in its asset buying program.
But it offered a more somber assessment of the economy than last month, saying the pickup in economic activity was pausing due to the effect of slowing overseas growth and the yen's strength.
Japan's economy will remain more or less flat for the time being before resuming a moderate recovery, the BOJ said in a statement announcing the policy decision.
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Central banks are flooding markets with liquidity as markets remain on edge about Europe's ability to put a floor under a bond market selloff that is pushing borrowing costs for countries such as Italy and Spain towards unsustainable levels.
The Fed has pledged to keep interest rates near zero until mid-2013 and the ECB cut its main interest rate to a record low this month, as the fallout from Europe's debt crisis stoked fears of a global economic slump.
The BOJ is also ready to inject huge amounts of liquidity in market operations and loosen monetary policy to fend off any contagion from Europe as it sees a global credit crunch as a real potential risk.
Japan's economy rebounded from a recession triggered by the March earthquake and tsunami, but is expected to slow sharply this quarter as the initial spurt driven by companies restoring supply chains and production facilities tails off.
Many in the bank are counting on support to growth from fiscal spending for reconstruction from the March disaster, but that may not be enough to offset weakening overseas demand.
The central bank loosened policy in October by topping up its asset buying scheme to ease the pain from sharp yen rises and the global slowdown on the export-reliant economy.
It kept policy on hold last month but revised down its economic assessment to say that while Japan's economy continued to pick up, its growth was moderating.
(Additional reporting by Kaori Kaneko; Editing by Joseph Radford and Chris Gallagher)