IMF declares end of deflation in Japan

WASHINGTON, July 28 (Reuters) The International Monetary Fund today declared that deflation in Japan had ended, but also said monetary policy should remain accommodative to allow inflation expectations to drift up.

In its 2006 review of Japan's economy, the IMF said consumer prices were likely to continue rising and the risk of a deflationary relapse had receded.

''The end of deflation and the smooth transition out of quantitative easing are milestones for monetary policy,'' the IMF said.

Earlier this month, for the first time in six years the Bank of Japan raised its key overnight lending rate to 0.25 percent from zero, affirming the end of a long era of deflation and economic stagnation.

The IMF said the Bank of Japan's monetary framework was well suited to the post-deflation era and flexible enough to give authorities room to respond to price stability risks.

''Adopting an appropriate post-deflation monetary framework, undertaking a well-designed fiscal consolidation, and boosting productivity through structural reforms are complementary elements of a strategy for sustained noninflationary growth,'' the IMF's board said in a statement.

The IMF said the medium-term growth outlook for Japan's economy was favorable and gross domestic product growth likely to reach 2.9 percent this year, slowing to just over 2 percent in 2007.

REUTERS SKU RS2059