TOKYO, Sept 19 - Japan's government admitted on Wednesday that the domestic economic outlook looked sombre, even though a concerted worldwide monetary easing this week appeared to soothe concerns of an imminent global financial crisis. The Bank of Japan's credit easing on Tuesday, part of a coordinated move against threats to the global financial system after last week's deadly aerial attacks in New York, helped the Nikkei average of Tokyo stocks continue its recovery toward the 10,000 threshold from recent 17-year lows. But the BOJ easing -- largely symbolic measures at a time when short-term interest rates are virtually zero -- was unlikely to halt Japan's persistent deflation, which has compounded its main problem, banks' bad loans, and hobbled consumer sentiment. Economics Minister Heizo Takenka said he might have been too optimistic to predict that the economy would recover if it endured a few years of painful reform. "The scenario has to be changed drastically due to the IT (information technology) sector slowdown and the effects of the terrorist attack," Takenaka told a meeting of the Upper House budget committee. Takenaka, in announcing Prime Minister Junichiro Koizumi's structural reform policy manifesto in June, called the next two to three years a period of "intensified adjustment", during which pain and low growth must be endured for a brighter future.

NO WAY OUT OF DEFLATION
Recent economic data have shown that Japan's gross domestic product (GDP) shrank by 0.8 percent in the April-June quarter and probably continued to contract in the following months. That had made a credit easing almost a certainty and the attacks in New York simply meant the announcement was advanced, the BOJ wrapping up its meeting in one day rather than two. The BOJ showed on Wednesday that it was delivering more than it promised when it said banks' current account deposits held at the central bank had grown to 9.5 trillion yen, far exceeding the "more than six trillion yen" targeted in Tuesday's easing steps. The balance in the non-interest bearing accounts reflects the amount of excess funds the BOJ has pumped into the money market, and Wednesday's huge increase reflects the BOJ's decision not to drain the extra yen funds in the system resulting from Monday's foreign exchange intervention, when it bought dollars for yen. Still, as the BOJ itself has admitted, Japan's ultra-loose monetary policy is in itself unlikely to help much in lifting its economy from the brink of its fourth recession in a decade. Finance Minister Masajuro Shiokawa said he appreciated the BOJ easing but he did not believe it was the best the central bank could do. He added that the most effective policy to halt deflation, which worsens banks' bad loan problem, was to lower the yen. "We are definitely not pursuing deflation and are in fact trying to push up prices. In order to do that, I think the most effective way is to lower the yen exchange rate," Shiokawa told a meeting of the Upper House budget committee. Japan intervened to buy dollars for yen earlier in the day for the second time this week. The intervention has had only a brief effect and the dollar hung below 118 yen for most of the day, within 1.5 percent of Monday's seven-month lows. Most analysts agree that at the heart of Japan's economic problem are banks' bulging non-performing loans. "The (BOJ) easing is not bad news, but liquidity so far isn't a problem for banks," said Koyo Ozeki, bank credit analyst at Merrill Lynch in Tokyo. "Banks' real problem is corporate solvency and in that sense the easing does not change anything for banks' woeful business environment." To cope with the problem ruling coalition parties have proposed expanding the role of the state-backed Resolution and Collection Corp (RCC), whose activity since its birth two years ago has been limited to buying bad loans from banks and re-collecting money or collateral from troubled borrowers. Some lawmakers want the RCC to borrow funds from the BOJ to lend to troubled borrowers or buy bad loans from banks at the book value -- as opposed to the much lower market value. But many in the government, including Koizumi himself, remained cautious about such a plan -- essentially using public funds to patch up holes left by bad loans. "I know that there are different opinions about the possibilty of expanding and strengthening the role of the RCC," Koizumi told the Upper House budget committee. In response to a question about allowing the RCC to buy bad loans at the book price, he added: "The government never said it had decided to take such measures or that they are important."