There is no quick fix to Europe's debt woes that threaten to escalate into a more widespread credit crunch, Bank of Japan Deputy Governor Kiyohiko Nishimura warned on Wednesday, voicing policymakers' growing concern about the deepening damage from the crisis.
Nishimura, known as one of more pessimistic board members, also said Tokyo must take appropriate action if currency moves are out of line with economic fundamentals in an attempt to keep markets on guard against another yen-selling intervention in the event of a renewed yen spike.
Europe's sovereign debt problems are essentially the result of expanding imbalances in the region ... thus we need to be aware that there is no immediate silver bullet for solving its problems, Nishimura said in a speech to business leaders in Kyoto, western Japan.
We need to brace ourselves for global financial market tension remaining high for a long time. We must be mindful of the risk of some shock triggering a widespread credit crunch, said Nishimura, who is one of the BOJ's two deputy governors.
Nishimura became the latest of the BOJ's nine-member policy board to warn that the euro zone debt crisis posed the biggest risk to Japan's economy with repercussions already felt widely across the globe.
Japan's economy has rebounded from a recession triggered by the March 11 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.
Data released earlier on Wednesday showed factory output rose more than expected as automakers continued to restock inventory overseas after restoring supply chains hit by the March earthquake.
Nishimura stuck to the BOJ's view that the world's third largest economy is set to resume a moderate recovery supported by the strength of emerging economies and reconstruction work.
But he added that the forecast faced various uncertainties with Europe's debt crisis seen weighing on global growth and on Japanese exports as the yen continues to draw safe-haven demand.
We need to be mindful of the fact that the yen will likely draw demand as a relatively safe currency as risk aversion increases among global investors amid continued tensions in global markets, Nishimura said.
If the yen rises sharply in a way that deviates from economic fundamentals, companies may accelerate the pace at which they shift production overseas in an irrecoverable way.
Concern about the impact of the yen's strength and Europe's debt crisis on Japan's economic recovery prompted its rating agency R&I announce a review for a possible downgrade of its AAA rating for the nation's debt.
R&I positively views the fiscal consolidation stance of the (Prime Minister Yoshihiko) Noda administration, which took office at the end of August, it said in a statement.
Nevertheless, with a delay in implementing measures for earthquake reconstruction and the persistently strong yen, the economic recovery lacks strength. Furthermore, the deepening European sovereign debt crisis and other factors are increasing uncertainty about external demand.
The BOJ, which meets for a rate review on December 20-21, could offer additional stimulus to help sustain the economy's recovery depending on how share prices and the yen perform, analysts say.
Europe's sovereign debt crisis has shown little sign of letup with investors fleeing the euro-zone bond market, causing yields in Italy to spike.
In Brussels, European finance ministers agreed to strengthen the euro zone's bailout fund and said they could ask the International Monetary Fund about more aid as bond yields surge across the region.
Nishimura said it would be natural to expect the International Monetary Fund to play a role in helping resolve Europe's debt woes, adding that in general Japan should do what it can to expand the global lender's functions.
Japan intervened in the currency market and eased monetary policy in October to ease the pain on the export-reliant economy from sharp yen rises and slowing overseas growth.
The BOJ kept monetary settings unchanged this month but has signaled its readiness to ease policy again if Japan's economic recovery comes under threat.
Nishimura surprised markets by proposing unsuccessfully in April that the BOJ should boost its asset purchases. He did not repeat the proposal in subsequent meetings and has voted with the majority.
(Editing by Michael Watson and Tomasz Janowski)
Corrects paragraph 2 to say appropriate policy action instead of resolute.