Thursday, the Bank of Japan retained its key interest rate as expected and downgraded its economic outlook.

The Policy Board of the central bank unanimously voted to hold the uncollateralized overnight call rate at 0.1%. The previous change in interest rates was a 20 basis point cut implemented in December 2008.

The central bank did not announce any new policy measures along with the monetary policy statement.

In its semiannual Outlook for Economic Activity and Prices, BoJ said Japan' economic outlook for the fiscal 2009 deviated downward from the assessment conducted in January. The central bank reiterated that the economic conditions in Japan have deteriorated significantly.

The economy is expected to shrink 3.1% this fiscal and to grow 1.2% in the fiscal 2010. According to the forecasts made in January, decline in fiscal 2009 was seen at 2% and growth for 2010 at 1.5%.

The pace of deterioration in economic conditions will likely moderate gradually and start to level out, the central bank stated. BoJ expects economic activity and corporate profits to gradually pick up from the latter half of fiscal 2009. Improvements in financial conditions are expected to support the recovery in the latter half of the projection period.

On the other hand, the central bank said private consumption recovery would possibly remain sluggish for the projection period, given the improvements in the employment and income situation tend to lag behind any recovery in corporate profits.

Commenting on the inflation environment, the central bank expects a 1.5% decline in the CPI excluding fresh food for this fiscal, larger than the 1.1% decrease estimated in January. The revision reflects the decline in the prices of petroleum products, the stagnation of food prices and the weakening demand conditions.

The rate of change in the CPI is projected to remain negative in fiscal 2010 given the persistence of the negative output gap and ongoing weak progress in wages. The estimate for 2010 was revised to a 1% decline from a 0.4% fall forecast previously.

In fiscal 2008, the BoJ forecasts that real GDP will shrink 3.2% compared to a 1.8% decline estimated in January. Meanwhile, the annual inflation rate for 2008 was left unrevised at 1.2%.

Last week, the Japanese government had lowered its GDP forecast for the current fiscal. On plunging exports, the economy is expected to contract 3.3% this fiscal year, the biggest drop since the government started to compile growth in 1955.

Washington-based lender, International Monetary Fund had said the second largest economy of the world would possibly shrink 6.2% in 2009, the largest decline among industrialized nations.

Earlier in the day, the Ministry of Economy, Trade and Industry said industrial output dropped 34.2% in March versus the 38.4% contraction in the previous month. At the same time, automobile production tumbled 50% in March from the previous year to 552,071 units, a separate report from the Japan Automobile Manufacturers Association showed.

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