April 27 (Bloomberg) -- Japan's consumer prices fell more than economists predicted and industrial production unexpectedly dropped, reducing the likelihood the central bank will raise interest rates anytime soon. The bank kept borrowing costs unchanged today.

Core consumer prices, which exclude fresh food, declined 0.3 percent in March from a year earlier, the second straight monthly drop, the government statistics bureau said today in Tokyo. Factory output slumped 0.6 percent and retail sales fell for a sixth month.

The Bank of Japan kept its benchmark interest rate at 0.5 percent today and may delay any increase for several months. In a semiannual report to be released at 3.15 p.m. in Tokyo, the central bank is likely to underline the need for raising rates, the lowest among major economies, to prevent excessive business investment and sustain the economy's expansion.

``These reports were weak,'' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. ``While the declines in prices may moderate, they're still going to be in negative territory for some time, making the hurdle for the Bank of Japan to raise rates very high.''

Economists surveyed by Bloomberg had estimated consumer prices would fall 0.2 percent and industrial production would surge 0.9 percent. Prices in March dropped at the fastest pace in two years. For the year ended March 31, nationwide core prices rose 0.1 percent, a second year of gains.

BOJ's Outlook

The yield on Japan's 10-year bond fell 3 basis points to 1.62 percent as of 2:12 p.m. in Tokyo. The Nikkei 225 Stock Average fell 0.6 percent. The yen traded at 119.41 per dollar compared with 119.54 before the rate decision, and was 162.46 against the euro after weakening to a record 162.84.

In today's outlook report, economists expect policy makers to cut their projections for consumer-price inflation for the year ending March 31 from 0.5 percent forecast in October.

All 52 economists surveyed by Bloomberg News expected Bank of Japan Governor Toshihiko Fukui and his policy board colleagues to keep the benchmark overnight lending rate unchanged today after they doubled the rate in February.

Today's outlook report will also outline the central bank's view on monetary policy. In October, the bank said interest rates need to be raised gradually to sustain the economy's expansion and prevent excessive business investment.

``It's very clear that on the growth front things have been fine but that the feed-through to inflation is missing,'' said Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo. ``The concern is whether the Bank of Japan will ignore this and keep up with the mantra that the strong growth will produce inflation, when that clearly hasn't happened.''

Retail Sales, Spending

Other reports today showed retail sales dropped 0.7 percent in March from a year earlier, the sixth straight monthly decline, and household spending rose a less-than-expected 0.1 percent. The unemployment rate held at a nine-year low of 4 percent.

Demand for workers may have peaked. The ratio of jobs to applicants, fell to 1.03 in March, the lowest in a year, the Labor Ministry said today. The number has declined since reaching a 14- year high of 1.09 in July.

``It's not clear why it's going down, since companies are saying they have labor shortages and expansionary hiring plans,'' said Jerram. ``One explanation is perhaps recruitment fatigue, with firms canceling vacancies they have found impossible to fill.''

Core prices in Tokyo, a harbinger of nationwide prices, were unchanged in April, the statistics bureau also said.

Waning U.S. Demand

``Today's report doesn't change my view that the end of deflation is in sight,'' Economic and Fiscal Policy Minister Hiroko Ota told reporters in Tokyo. ``Still, we need to keep monitoring prices'' to ensure the economy emerges from deflation.

Production fell 1.4 percent in the first quarter from the last three months of 2006, the trade ministry said, indicating manufacturers are concerned that global demand will slow as the U.S. economy stalls.

Exports to the U.S., a destination of a fifth of Japanese goods shipped overseas, rose at the slowest pace in more than two years last month after demand for construction equipment cooled.

The International Monetary Fund slashed its forecasts for U.S. and global growth this month, predicting the world's largest economy to expand at its slowest pace in five years.

The U.S. economy expanded an annual 1.8 percent last quarter, economists predict, the weakest pace in more than a year, depressed by the longest homebuilding slump in a generation. The Commerce Department will report the GDP data today.

``It will be hard for the Bank of Japan to raise rates as long as the outlook for U.S. growth remains uncertain,'' said Akio Makabe, professor of economics at Shinshu University.

China, Europe

Still, exports to China and Europe rose to a record in March, indicating demand from those markets may help to offset the U.S. slowdown. Manufacturers expect production to climb 1.5 percent in April from a month earlier, and in May to advance 1.4 percent, the trade ministry said.

Honda Motor Co., the world's second-largest maker of gasoline- electric cars, plans to increase Chinese sales by more than a fifth this year as it taps demand for fuel-efficient automobiles. Honda increased production by 2.3 percent in March, the 10th straight month of gains.

The Japanese economy probably grew at an annualized 1.7 percent pace last quarter, after the fastest expansion in three years in the final three months of 2006, according to the median estimate of 18 economists surveyed by Bloomberg News this week.

``Given the soft patch of data we're looking at, we'll need a couple of GDP releases before the Bank of Japan is emboldened to raise interest rates again,'' said Huw McKay, senior international economist at Westpac Banking Corp. in Sydney.

Gross domestic product numbers for the first quarter will be released on May 17, the day of the bank's next rate decision.

To contact the reporters on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net; Lily Nonomiya in Tokyo at lnonomiya@bloomberg.net

Last Updated: April 27, 2007 01:14 EDT