BOJ keeps rates on hold; Moody's ups bond rating

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TOKYO, Oct 11 (Reuters) The Bank of Japan voted to keep interest rates unchanged as widely expected on Thursday, as it awaits more evidence on fallout from U.S. subprime woes before pushing on with its plans to raise rates.

The 8-1 vote to maintain the key policy rate at 0.5 percent came shortly after ratings agency Moody's Investors Service raised Japan's domestic-currency government bond rating by one notch to A1, citing expectations for further fiscal reform by the government that could help ease a huge public debt burden.

Hawkish board member Atsushi Mizuno, who had been proposing a rate rise since July, was the sole dissenter from the BOJ decision, prompting yen selling by some market traders who had speculated that some other board members might join him in calling for a credit tightening.

But the vote count did little to alter dominant market views that the BOJ's next rate rise will not come until December or even early next year in light of still shaky world financial markets and slowing U.S. economic growth.

Swap contracts on the key policy rate currently price in roughly a 65 percent chance of a rate hike by December and about a 75-80 percent chance by January, unchanged from before the BOJ rate announcement.

Still, some economists said Mizuno could get more support as early as the next policy meeting on Oct. 31 if markets remain calm.

''If markets regain composure and if the BOJ becomes more confident (that risks are diminishing) after the Group of Seven meeting (on Oct. 19), the BOJ may start considering a rate hike,'' said Susumu Kato, chief economist at Calyon Securities.

''Another board member, such as Miyako Suda, may join Mizuno at the next meeting, which could pave the way for a credit tightening in November,'' he said. Suda is regarded as one of the more hawkish members of the BOJ board.

The yen slipped slightly to around 117.25 against the dollar from around 117.15 after the BOJ announcement, while the lead JGB futures edged up to 134.47 from around 134.25 minutes before the BOJ's decision.

The focus is now on BOJ Governor Toshihiko Fukui's news conference for clues on the timing of the next rate hike and his views on recent global economic conditions.

The BOJ will release its monthly economic report for October at 3 p.m. (0600 GMT) and Fukui will meet reporters at 3:30 p.m. (0630 GMT).

The BOJ has kept its benchmark rate unchanged since February, when it raised it a quarter-point from 0.25 percent. Markets had earlier thought a hike to 0.75 percent this autumn was a near certainty, given the central bank's pledge to raise rates gradually so as to restore them to more normal levels.

But that has changed dramatically since the spillover from U.S.

subprime mortgage problems rocked markets and caused a credit squeeze, prompting the Federal Reserve to cut rates in September and the European Central Bank to pause in raising rates.

While surprisingly firm U.S. employment data last week eased investor fears of a possible recession in the U.S. economy, the BOJ will likely scrutinise more data to see whether slowing growth in the United States -- Japan's biggest export market -- could severely undermine Japan's export-reliant economic recovery.

Firm exports and capital expenditure growth have played a key role in supporting Japan's economy, which is enjoying its longest expansion in post-World War Two history.

Government data released earlier on Thursday showed that core machinery orders, a highly volatile figure regarded as a leading gauge of capital spending, fell 7.7 percent in August from July.

While that was a bigger drop than a consensus forecast of a 6.0 percent drop, many economists said the decline was largely a reaction to a 17.0 percent jump in July and thus was no cause for concern.

''Capital expenditure growth isn't that strong but not so weak either, and the risk of it falling sharply ahead is slim,'' said Yoshiki Shinke, senior economist at Dai-ichi Life Research Institute.

Separate government data showed that Japan's current account surplus rose 42.1 percent in August from a year earlier, against a median market forecast for a 49.8 percent expansion. Exports rose 14.0 percent from a year earlier to mark the 45th straight month of increase.

REUTERS KR SSC1144

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