July 3 (Bloomberg) -- Bank of Japan policy board member Kiyohiko Nishimura said keeping interest rates on hold for a long time would be imprudent because it may lead to volatile changes in economic growth and prices.

``The policy rate should be adjusted gradually to the trend of general economic conditions,'' Nishimura said in a speech in Washington yesterday. ``To stand pat for a long period of time is not a prudent strategy,'' he said, adding that to do so could cause ``unnecessary swings in economic activity and prices.''

Nishimura, 54, was the first policy maker to comment after the bank's quarterly Tankan survey showed confidence of manufacturers held near a two-year high and companies plan to increase spending this year. The survey suggests the bank will raise rates in August, said economist Atsushi Nakajima.

``The Tankan confirmed the firm footing of Japan's overall economy,'' said Nakajima, chief economist at Mizuho Research Institute. ``It provides a push for an August rate increase.''

The yen traded at 122.34 per dollar at 1:02 p.m. compared with 122.42 late yesterday in New York.

The bank published a draft of Nishimura's speech on its Web site today. Deputy Governor Toshiro Muto will speak in Tokyo later, and the draft of his speech will be posted on the bank's Web site around 4 p.m. Japan time.

August Rate Increase

The Bank of Japan raised the key overnight lending rate to 0.5 percent in February, the second increase after ending its zero-rate policy in July 2006. Investors see a 74 percent chance the bank will raise the rate to 0.75 percent in August, according to calculations by Credit Suisse Group based on the exchange of interest payments.

Nishimura said adjustment of interest rates ``cannot be pre-scheduled or occur at some fixed interval, since it should be in line with the general economic improvement, which never follows a fixed schedule.'' Should economic growth accelerate, that could require a ``large adjustment'' in the future, he said.

Confidence among large manufacturers was unchanged at 23 points in June, near December's two-year high of 25, the Tankan showed. Sentiment among service companies held at a 15-year high.

The world's second-largest economy has achieved ``increasingly stable growth since the current recovery started some five years ago,'' Nishimura said. Japan's economic expansion is the longest in more than 60 years.

Households' Currency Investing

Nishimura also commented on the foreign-exchange market, saying households are helping to moderate currency swings by betting against professional investors.

``The arrival of Japanese households as major investors seems to have affected foreign-exchange markets,'' Nishimura said. Retail investors' strategy of selling yen during rallies helped reduce volatility on one-month dollar-yen options to 5.85 percent on June 21, the lowest since the bank began compiling data in August 1992, compared with 10.15 percent on March 5.

Japan's retail investors ``are buying foreign currencies on dollar dips and selling at a profit,'' said Masafumi Yamamoto, currency economist at Nikko Citigroup Ltd. in Tokyo.

Japanese households' holdings of foreign currency- denominated assets have risen from about 0.5 percent of their total financial assets in 1994-1996 to 2.8 percent in March, Nishimura said. Their holdings of investment trusts denominated in foreign currencies rose to 31 trillion yen in March from 9 trillion yen three years earlier, he said.

``The gnomes of Zurich were accused in their day of destabilizing markets,'' Nishimura said. ``The housewives of Tokyo are apparently acting to stabilize them.''

Foreign-Exchange Risk

Nishimura went on to highlight the risk of households suddenly changing their investment strategies.

``We do not know how far the contrarian strategies of Japanese retail investors can go,'' Nishimura said. ``A sudden change in their behavior is likely to shift the direction and the magnitude of trading in many foreign-exchange markets.''

Bank of Japan Governor Toshihiko Fukui has warned investors against the risks of one-way bets on currencies and said a sudden reversal of such trades could affect financial markets.

The yen has slid 2.7 percent against the dollar and 5.7 percent versus the euro this year as investors borrowed and sold the currency to purchase higher-yielding assets in so-called carry trades. When the carry trade collapsed in 1998 following Russia's debt default, the yen jumped 10 percent against the dollar in two days and ended the year 15 percent higher.

Finance Minister Koji Omi last week said it's ``important'' for investors and traders to realize the risk of making one- sided bets. The Group of Seven nations warned about the risk of trading against the yen in meetings in February and April.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at

Last Updated: July 3, 2007 00:09 EDT