Dec. 17 (Bloomberg) -- The Bank of Japan may this week follow the Federal Reserve deeper into the zero interest-rate world, beating European counterparts to the punch and forcing it to mull unorthodox methods to revive its economy.

Investors see a 54 percent chance that the Bank of Japan’s policy board will reduce its overnight call rate from 0.3 percent at this week’s meeting after the Fed yesterday pared its key rate to as low as zero. That would leave it to pursue unconventional ways to boost economic growth such as by buying corporate bonds to reduce market borrowing rates.

“The Bank of Japan will want, and has to be seen, to match the Fed in its response to the sharp economic slowdown,” said Julian Jessop, chief international economist at Capital Economics Ltd. in London.

The use of so-called quantitative measures to lower borrowing costs in the U.S. and Japan may emerge as a global theme in 2009 should the recession and the ongoing credit crunch oblige central banks in Europe to cut interest rates.

“Central banks everywhere are going to be pushing rates closer to zero and thinking of new ways to kick start their economies,” said David Owen, chief economist at Dresdner Kleinwort in London. “The financial crisis is still going and recessions are getting worse.”

The Fed yesterday said it will target a federal funds rate of between zero and 0.25 percent in an unprecedented move that took it below the Bank of Japan’s rate for the first time since 1993 and pushed the yen to its strongest in 13 years against the dollar. The cut, and lobbying by Finance Minister Shoichi Nakagawa, has put pressure on Japanese policy makers to follow suit.

Weak Economy

“The combination of the very weak domestic economy, the very strong yen, and what is likely to be intense political pressure on the BOJ will, we think, force an easing move sooner rather than later,” said John Richards, head of debt markets strategy for the Asia-Pacific region at Royal Bank of Scotland Plc in Tokyo. “There is little to be gained by waiting.”

In Europe, the European Central Bank and Bank of England still have more room to maneuver than their counterparts in the U.S. and Japan, with benchmark interest rates of 2.5 percent and 2 percent respectively.

Bank of England Governor Mervyn King has refused to rule out that the main U.K. rate could reach zero and said on Nov. 25 that there would need to be “close coordination” between the government and the central bank in such circumstances because monetary policy then becomes like debt management. Fellow policy maker David Blanchflower said in an article published today that there is a risk U.K. inflation may turn negative.

“In circumstances when there is a danger of deflation and policy interest rates are approaching the zero bound, it is appropriate to consider the use of alternative policy measures, including quantitative easing,” he wrote in an article for the Royal Economic Society newsletter.

Quantitative easing “is something we’re not looking at, at the moment,” Chancellor of the Exchequer Alistair Darling told lawmakers on Dec. 10. “Interest rates are at 2 percent. They have some way to fall. It’s not something people should get too excited about.”

Trichet’s Signal

ECB President Jean-Claude Trichet is signaling even greater skepticism that such a policy will be needed, saying this week that there’s a limit to how far it can cut rates, indicating a possible pause in January. The Frankfurt-based bank this month cut its benchmark rate by an unprecedented 75 basis points.

European policy makers have suggested they would now prefer to focus on prodding banks into resuming lending between themselves rather than pushing interest rates much lower amid frozen credit markets. Options include cutting the rate at which banks deposit funds at the central bank overnight or guaranteeing short-term interbank lending.

That may leave the Swiss National Bank as the first European central bank to enact zero rates, having cut its benchmark to 0.5 percent. While President Jean-Pierre Roth said the rate could still go lower, pointing out it was at 0.25 percent in 2003, colleague Thomas Jordon says the bank may eventually resort to buying bonds, or intervening in currency markets.

Eight Warnings

Like Trichet, Bank of Japan Governor Masaaki Shirakawa had also indicated wariness about lowering his rate again after cutting it for the first time in seven years in October. He has said at least eight times that further reductions may impede the flow of funds in the money market by diminishing returns and making it unprofitable to trade.

Still, this week he indicated that the option of pushing rates to zero percent remains open.

“I am not going to predetermine that measures should or shouldn’t be used,” he said, when asked whether policy makers would consider reintroducing the 2001-2006 policy of pumping cash into the economy while holding borrowing costs near zero. The central bank will implement policy “appropriately,” he said.

To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.netSimon Kennedy in Paris at skennedy4@bloomberg.net;

Last Updated: December 17, 2008 06:33 EST