Feb. 7 (Bloomberg) -- Japanese household spending is stronger than consumer confidence reports suggest, central bank Deputy Governor Kazumasa Iwata said.

``Consumer spending is solid, even though consumer confidence has deteriorated considerably,'' Iwata, 61, said today in a speech in Kochi, western Japan. Iwata said a cycle of higher profits feeding into wages and spending remains intact, comments echoed by Governor Toshihiko Fukui in parliament today.

Iwata, the sole board member to vote against the central bank's most recent interest-rate increase a year ago, said persistent financial-market turmoil is a risk to the global economy. After the speech traders maintained expectations that the bank's next move may be to cut rates rather than pursue its policy of gradually raising them.

``Iwata has been cautious about the outlook for a long time,'' said Hiroshi Shiraishi, an economist at Lehman Brothers Japan Ltd. in Tokyo. ``But because of his position as deputy governor, he's obliged to stick with the BOJ's basic stance.''

Calculations by JPMorgan Chase & Co. using overnight interest-rate swaps show a 37 percent chance of a reduction in the benchmark rate from 0.5 percent by August. Japan's borrowing costs are already the lowest in the industrialized world.

``The biggest cause for uncertainty for the global economy is the fact that the rout in international financial markets hasn't subsided,'' Iwata said.

Japan's Nikkei 225 Stock Average has tumbled 14 percent this year on concern that a U.S. slowdown will spread globally and cut demand for exports.

U.S. Economy

Iwata later told reporters that the risk of a U.S. recession could rise should major economic indicators keep deteriorating. He also said the U.S. economy may pick up in the second half of the year as lower borrowing costs and stimulus measures take effect.

The Federal Reserve cut the benchmark rate to 3 percent last month in the fastest easing of U.S. monetary policy since 1990. The U.S. Congress is considering President George W. Bush's $146 billion plan to help the economy avoid a recession.

Lawmakers from Japan's ruling Liberal Democratic Party and opposition Democratic Party of Japan met today to discuss replacements for Fukui, Iwata and fellow Deputy Governor Toshiro Muto, whose terms all expire on March 19.

``A change in board members could lead to some sort of change in monetary policy,'' Iwata said at the news conference. Economists say Muto is the favorite to replace Fukui.

Consumer Spending

Iwata said a decline in consumer confidence to a four-year low in December was because of rising food and gasoline prices. Even with consumers becoming more pessimistic, household spending climbed 2.2 percent in the month.

``Confidence should recover as the worst fears about inflation prove to be overdone,'' said Julian Jessop, chief international economist at Capital Economics Ltd. in London. Record gasoline prices and media hype about increases for staples like instant noodles and mayonnaise has created the impression that inflation is worse than it is, Jessop said.

Fukui today highlighted the central bank's dilemma of dealing with the risk that higher oil prices may slow economic growth as well as accelerate inflation.

``On one hand, oil prices spur the rate of price increases, and at the same time they push down economic growth and exercise deflationary pressure,'' Fukui told at a parliament committee in Tokyo. ``We must closely monitor both'' risks.

Higher oil and commodity costs are forcing companies to foist price increases onto consumers whose wages are falling.

Faster Inflation

Consumer prices excluding fresh food rose 0.8 percent in December from a year earlier, the fastest pace in almost a decade. Both Fukui and Iwata said the inflation measure could accelerate in coming months.

``Should oil prices stay at these levels, core consumer prices could rise to around 1 percent,'' Iwata said. ``Still, the push from energy prices will gradually diminish.''

Iwata also said housing investment is beginning to recover from a slump after the government imposed stricter rules for obtaining building permits following a scandal involving the falsification of earthquake-resistance specifications.

``It appears that the worst is over in terms of how the revisions to the Building Standards Law affected the decline in housing starts,'' Iwata said. ``We'll see the negative effect of this temporary decline in housing investment wear off and push up growth in fiscal 2008.''

Housing starts fell 19.2 percent in December, slower than the 27 percent drop in November and September's 44 percent plunge to a four-decade low. A decline in housing investment wiped 1 percentage point from economic growth in the third quarter, according to Dai-Ichi Life Research Institute Inc.

Iwata said there's ``no immediate need'' for the Bank of Japan to alter the amount of government debt it purchases. The central bank buys 1.2 trillion yen of government bonds each month.

To contact the reporter on this story: Lily Nonomiya in Kochi at lnonomiya@bloomberg.net

Last Updated: February 7, 2008 01:37 EST