BOJ holds rates, Japan industrial output slides

The weak data, along with a slump in U.S. consumer confidence, pushed up Japanese bond prices, amid worries that American economic woes were hitting the big exporters that are sustaining Japanese growth.

The central bank, which has its key interest rate already at a low 0.5 percent, is expected to cut its growth outlook and raise its inflation forecast in a half-yearly economic report due at 3 p.m. (0600 GMT).

Japanese industrial output fell 3.1 percent in March -- the biggest monthly fall for at least five years and far below a market median forecast of a 0.8 percent drop."This could raise concerns that the Japanese economy is slowing down sharply in the January-March quarter," said Yasuhide Takahashi, economist at Nomura Securities.

"Output is also not expected to recover much in coming months after a sharp drop in March. We think the economy will remain sluggish until the third quarter of this year."

The weakness follows a slump in U.S. consumer confidence to a five-year low and falling U.S. house prices, showing consumers have yet to buy into the view among some investors that the worst is over in the global credit crunch.

The U.S. data, and a U.S. rate review later on Wednesday, sent Treasuries higher. Those moves, along with the weak Japanese figures, boosted the price of Japanese government bond futures and interest rate futures which have fallen sharply in the past week on worries about rising inflation. June 10-year JGB futures rose as much as 0.48 point. "It seems like the pull-back in JGBs that took place on Monday and last Friday may be over," said Mari Iwashita, senior strategist for Daiwa Securities SMBC's fixed income research department.

OUTLOOK WORRIES
Seasonally adjusted unemployment dipped to 3.8 percent in March. While that was better than the flat result of 3.9 percent in a consensus market forecast, economists focused instead on a fall in the ratio of job offers to job seekers.

That slipped to 0.95, meaning 95 jobs were available per 100 applicants, below a median forecast of 0.96 and continuing a fall from a peak of 1.07 last June. "The trend shows hiring is slowing for the moment especially among small businesses, while big corporations continue to recruit new employees briskly," said Yoshiki Shinke, senior economist at Dai-ichi Life Research.

Overall household spending fell 1.6 percent in March from a year earlier in price-adjusted real terms, countering a median market forecast for a 0.5 percent increase and further signalling weak consumer spending.
Such weakness in the domestic economy will likely keep the BOJ concerned about downside risks in coming months.

Still, like other central banks, the BOJ faces rising fuel, raw materials and food prices as it ponders what to do with rates, already at a very low 0.5 percent. Japan's core annual inflation rate hit a decade high of 1.2 percent in March.

As the expectation is growing that the Federal Reserve's easing cycle is coming to an end after one more 0.25 percentage point cut later on Wednesday, markets are now pricing in a BOJ rate hike.

Swap contracts on the overnight call rate are pricing in around a 60 percent chance of a rate hike by the end of the year.That is a sea change from just a few weeks ago when investors had been looking for a BOJ rate cut as the credit crisis weighs on global economic growth.

Housing starts, hit hard by a regulatory change last year, and a private manufacturing survey added to the weak figures.Housing starts in Japan fell 15.6 percent in March from a year earlier, below a median market forecast for a 6.7 percent drop.

The NTC Research/Nomura/JMMA Purchasing Managers Index, which gives an early snapshot of the health of manufacturing, declined to a seasonally adjusted 48.6 in April from 49.5 in March and was the lowest since 48.1 in February 2003. A reading below 50 points to a contraction in manufacturing activity.