The Bank of Japan is prepared to act promptly and decisively if judged necessary to ensure the stability of financial markets, Governor Masaaki Shirakawa said Monday. He reiterated that the central bank will maintain the extremely accommodative financial environment and provide steady support for Japan's economy.

Speaking at a meeting with business leaders in Nagoya, Shirakawa said the central bank will do its utmost to overcome deflation both in terms of monetary easing and ensuring the stability of the financial markets. In coping with deflation, first the BoJ should improve the supply and demand balance of the economy and prevent a vicious circle between economic activity and prices, he said.

According to Shirakawa, the starting point of the current price decline was the rapid contraction of financial and economic activities since the autumn of last year. Consequently, the supply and demand balance deteriorated considerably. So as to deal with such a situation, he said, it is necessary to prepare an environment conducive to a sustainable expansion of final demand, such as business fixed investment and private consumption.

On November 27, Japanese Finance Minister Hirohisa Fujii said he would contact U.S. and European authorities to act on currencies if necessary. "I am nervously watching the foreign exchange market carefully", the minister told reporters. Fujii also hinted at the prospect of a statement from the Group of Seven nations.

The central bank chief added that the BoJ is paying due attention to the effects of the recent appreciation of the yen on business sentiment of the firms and to the effects of international financial developments since last week on the financial markets. "It would be important, above all, for a central bank to examine the economy without prejudgment."

The comments came ahead of his meeting with Prime Minister Yukio Hatoyama later this week. On November 20, the Hatoyama government had declared that the economy is in deflation, the first official announcement of deflation since mid-2006. Core consumer prices, which excludes fresh food from the price basket, dropped 2.2% in October from a year earlier.

Today, Shirakawa also shared the view of "mild" deflation in the second largest economy. According to the BoJ's forecast in October, the CPI excluding fresh food, would fall 1.5% in fiscal 2009 and would drop 0.8% in fiscal 2010 and a 0.4% decline in fiscal 2011. Chief Cabinet Secretary Hirofumi Hirano reportedly said Shirakawa and Hatoyama will discuss the measures to support the economy, including quantitative easing.

In October, BoJ policymakers decided to stop outright purchases of commercial papers and corporate bonds at the end of 2009 as the central bank's assessment showed a marked improvement in conditions. Earlier this month, the Organisation for Economic Co-operation and Development warned against lingering deflation in the economy and said an increase in the central bank's bond purchases would help in battling deflation.

Shirakawa noted that the pace of improvement in Japan's economy is likely to remain moderate until around the middle of fiscal 2010, as pressures for adjusting employment and wages are likely to remain. He said word 'moderate improvement,' is used to also convey cautious judgments that, while the economy has gotten out of a deteriorating phase, the level of economic activity remains low and the pace of future recovery will not likely to be smooth. Further, he sees a possibility that the momentum for Japan's economic recovery will temporarily slow at around the spring of 2010.