In its semi-annual economic outlook published on Thursday, the BOJ said it expects the economy to contract 3.1% in the 2009 fiscal year, down from the 2.0% decline previously forecast.

Earlier in the day, the BOJ's Policy Board voted unanimously to keep the overnight call rate targeted at 0.1%.

According to the central bank, domestic private consumption will continue to deteriorate. However, the pace in export and production declines will ease as inventories are adjusted both domestically and abroad.

"Therefore, the pace of deterioration in economic conditions will likely moderate gradually and start to level out," the central bank said.

The BOJ also noted that corporate financing conditions had begun to loosen compared to the latter part of 2008 due to improved issuing conditions in both the corporate bond and commercial paper markets.

"However, given the deterioration in corporate profits, the situation as a whole remains severe as an increasing number of firms are reporting that their financial positions are weak and lending attitudes of financial institutions are tight," the bank added.

Nevertheless, CP and corporate bond market improvements are expected to continue, with further increases in bank lending due to both low interest rates and policy measures taken recently.

"The tightness in corporate financing, therefore, is likely to ease gradually," the BOJ said in its report.

Looking ahead to the 2010 fiscal year, which begins on April 1, 2010, the BOJ projects that the economy will recover to a growth rate of 1.2%, with estimates out of the Policy Board ranging from +0.8% to +1.5%.

However, the BOJ also noted that downside risks should be paid attention to.

With the revised economic outlook, the central bank has amended its projections for core inflation and now expects consumer prices, excluding the effects of fresh food prices, to fall 1.5% this fiscal year, down from to 1.2% gain forecast initially.

"The year-on-year rate of change in the CPI (excluding fresh food) is likely to record a somewhat large decline through the middle of fiscal 2009, but the rate of decline is expected to moderate gradually thereafter," the central bank said.

"If these developments continue, there are prospects for the economy to return to a sustainable growth path with price stability in the longer run."

By Todd Wailoo, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Stephen Huebl, This email address is being protected from spam bots, you need Javascript enabled to view it

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