Oct. 20 (Bloomberg) -- The Bank of Japan will stick to its 2 1/2-year old policy of keeping interest rates near zero even as the country's economy shows signs of recovery, Governor Toshihiko Fukui said. ``We realize it's important for us to support the economy's recovery movements and ensure they take root,'' Fukui said in a speech at the bank's quarterly branch managers meeting in Tokyo. The central bank will keep a close eye on financial markets and overseas economies, Fukui told the heads of the bank's 32 domestic branches and offices in New York, London and Hong Kong, who are meeting today at the bank's Tokyo headquarters to discuss regional economies. The bank last week raised its evaluation of the economy for a second straight month, saying it's more optimistic as business sentiment and prospects for export growth improved. An unstable yen is an uncertainty for exports, the engine for growth, the bank said.
Capital spending by exporters such as Sharp Corp. and Canon Inc. fueled a 3.9 percent annual pace of economic growth in the second quarter, the fastest in 2 1/2 years. The yen's almost 6 percent rise against the dollar the past month may slow the recovery by eroding exporters' profits and fueling deflation, economists said. The yen traded at 109.71 yen to dollar at 10:27 a.m. in Tokyo, from 109.38 late Friday in New York. The bank last week decided to pump more cash into the economy to protect the recovery and underline the zero-rate policy. That would also help slow the yen's gains, economists say. The central bank cut interest rates almost to zero in March 2001 and promised to leave borrowing costs there until nationwide core consumer prices, excluding fresh food, stay above zero from the year-before level ``in a stable manner.'' Fukui today repeated the pledge. Japan's key consumer price index hasn't risen since April 1998.
``The foundation for a gradual recovery in Japan's economy is being laid,'' Fukui said in the speech. Still, more time is needed for domestic demand to gain momentum because Japanese companies are struggling to reduce debt and cut labor costs, he added. Japanese banks should accelerate efforts to dispose of bad loans, the governor added. Japanese banks were burdened with 44.5 trillion yen ($408 billion) in bad loans as of March 31, down from 52.4 billion yen of a year earlier. Managers of the central bank's Osaka, Nagoya, Sapporo and Fukuoka branches will brief the press on their economies later today. //www.bloomberg.com