Nov. 2 (Bloomberg) -- Bank of Japan Governor Toshihiko Fukui said global financial markets remain volatile and the central bank must ``implement monetary policy carefully,'' amid speculation interest rates won't increase anytime soon.

Though the effect of a U.S. housing recession on Japan has been limited, ``we can't deny the possibility of a further slowdown in the U.S. economy,'' the governor told the fiscal and financial committee of the Parliament's lower house today.

The central bank on Oct. 31 cut its forecasts for this year's inflation and economic growth and left its key rate at 0.5 percent, the lowest among major economies. Fukui said on the same day that risks for Japan are increasing amid financial- market gyrations and uncertainty about the U.S. outlook.

``The Bank of Japan's acknowledgment of the growing downside risks to growth almost certainly rules out a rate hike this side of Christmas,'' said Julian Jessop, an economist at Capital Economics Ltd. in London

Fukui today said there are ``considerable risks'' that bond yields will fluctuate in either direction and the bank must consider financial-market movements when deciding policy. Global inflation warrants caution, he added.

Japan's 10-year bonds rose, heading for the biggest gain in seven weeks, after a slide in stocks drove demand for government debt. The yield on Japan's 10-year bond fell 5.5 basis points to 1.61 percent as of 12:49 p.m. in Tokyo.

Filtering to Households

The improvement of the corporate sector is filtering into households at a slower pace than the bank expected, Fukui said. Wage growth has also been sluggish and that may be one reason why policy makers cut this year's inflation forecast, he said. Wages fell 0.5 percent in September from a year earlier.

Fukui said the bank still expects Japan's economic growth to be sustained and consumer prices to resume rising. The bank needs to raise rates gradually as long as the economy and prices develop as expected, he said.

The policy board has no preset schedule for raising rates and must monitor both ``upside and downside risks'' -- or the possibility that growth may slow as well as accelerate excessively, the governor said. The bank's basic stance is to take ``early'' action, he said.

Japan's economy will expand 1.8 percent in the year ending March 31 and 2.1 percent in the following year, policy makers said in their semiannual outlook report. They had predicted 2.1 percent growth for both years in April.

Consumer Prices

Consumer prices excluding fresh food will be unchanged this year and rise 0.4 percent in fiscal 2008, the board said. In April it forecast a 0.1 percent gain this year and 0.5 percent in the next.

Fukui said a delay in home construction following a change to building regulations was a reason for the cut in this year's growth estimate. Housing starts slumped 44 percent in September to the lowest in four decades because of the stricter rules.

Speaking at the same committee, Deputy Governor Kazumasa Iwata said interest-rate gaps between Japan and other countries tend to encourage so-called yen carry trades, in which investors borrow cheaply and buy higher-yielding assets overseas.

One-sided bets may prompt investors to unwind the trades suddenly and shake financial markets, Iwata said. Currencies are also influenced by other countries' economic growth and inflation, he said.

In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency moves erase those profits.

Financial-market movements could affect economic growth and prices and the central bank needs to carefully examine risks and implement policy appropriately, Iwata said.

To contact the reporters on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net; Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

Last Updated: November 2, 2007 00:03 EDT