Japan central bank raises growth forecast

Japan's central bank Thursday raised its growth forecast to 2.6 percent for this fiscal year as recovery in Asia's biggest economy inches painfully ahead thanks to demand in emerging nations.

"Japan's economy shows further signs of moderate recovery, induced by improvement in overseas economic conditions," the Bank of Japan said, raising its GDP forecast from the 1.8 percent it predicted in April.

"Exports and production have been increasing mainly due to high growth in emerging economies and increased global demand for IT-related goods," the bank said in a statement after a two-day board meeting.

Demand especially from China and Southeast Asia has helped Japanese exporters. Japan's sluggish growth sharply contrasts with that of China, which Thursday said its economy had expanded 10.3 percent in the second quarter.

Despite the more upbeat assessment, the Bank of Japan (BoJ) kept its key lending rate unchanged at 0.1 percent, as expected, and said it would "aim to maintain the extremely accommodative financial environment".

The rate has not changed since December 2008 -- the lowest point in a global financial crisis which plunged Japan into recession -- and lags behind other Asian economies that have recently tightened their monetary policies.

The bank slightly downgraded its GDP forecast for the fiscal year 2011 to 1.9 percent from a previous estimate of 2.0 percent.

The BoJ also warned of risks from Europe, where a fiscal crisis has threatened the global recovery. The euro has plummeted against the yen recently, hitting Japanese exporters and eroding their competitiveness.

Japan fell into a severe recession amid the global financial crisis but clawed out of it in early 2009. Since then its recovery has gathered steam, with GDP reaching an annualised five percent in the first quarter of 2010.

Sustaining growth is a key challenge for new Prime Minister Naoto Kan and his Democratic Party of Japan (DPJ), but the centre-left government also faces another challenge -- reducing the world's biggest public debt mountain.

Kan has warned of a Greece-style debt crisis and proposed doubling the five-percent consumption tax in order to fix tattered finances -- public debt has spiralled to nearly 200 percent of GDP.

The talk of tax hikes cost his party dearly at elections last weekend at which the DPJ lost the upper house, but the International Monetary Fund (IMF) on Wednesday warned Japan that there was no way around the fiscal pain.

Bringing down Japan's public debt "will require a large and protracted adjustment that will be made more credible by an early increase in the consumption tax," the Washington-based fund said.

The BoJ in its statement also warned that overcoming deflation, a general fall in prices which has long hobbled Japan's economy, and achieving sustainable growth remained a "critical challenge".

Japan has been stuck in a deflationary spiral since its asset bubble burst in the early 1990s, and consumer spending has never fully recovered to become a major driver of growth.

The BoJ upgraded its forecast for its core consumer price index (CPI), the main gauge of inflation, for the year ending March 2011 to minus 0.4 percent, from an April forecast of minus 0.5 percent.

For the following fiscal year, it kept its forecast unchanged at 0.1 percent. Inflation could rise more than expected if there is higher demand from emerging economies, the bank said.