TOKYO, JAPAN - THE Bank of Japan will probably downgrade its view of the economy and keep rates on hold next week in a signal that crumbling export markets can no longer offer factories enough business to keep Japan out of recession.

And with consumers tightening their belts in the face of high food and fuel costs and slow wage growth, the BOJ will have little room to raise its benchmark rate from a low 0.5 per cent this year, analysts said.

Signs of trouble have piled up since the BOJ's last policy meeting in July, when it cut its assessment of the economy to warn that growth was slowing further under the strain of high raw material costs.

'Up until July, the BOJ has said that while domestic demand was weak, solid external demand would keep production afloat,' said Masaaki Kanno, chief economist at JPMorgan Securities.

'But it has now become clear that exports, the last hope for Japan's economy, cannot be relied upon.'

While a shrinking economy is its main focus, the BOJ is on guard against rising prices. Annual core consumer inflation hit a decade-high of 1.9 per cent in June on the surging cost of food and fuel.

But the BOJ's task is less complicated than that of the European Central Bank or the US Federal Reserve as rises in energy and food prices have not fed through into wages and other costs.

Money market futures are pricing in virtually no chance of a BOJ rate hike over the next year.

The BOJ's policy board is expected to announce its rate decision some time between noon and 2pm (9-10am Singapore time) on Tuesday at the end of a two-day meeting.

It will also release its view on the economy in a statement alongside the rate decision, followed by a more detailed assessment in a monthly economic report a day later.

GLOOMY OUTLOOK

The annualised rate of contraction of 2.4 per cent in Japan's economy is a contrast to the 1.9 per cent growth in the same quarter in the United States. Analysts expect the euro-zone economy to have contracted slightly during the quarter.

Japanese industrial output has fallen for two straight quarters and is highly likely to fall further in the third quarter. In the last half century, two quarters of contracting factory output have always pushed the Japanese economy into recession as defined by the government.

Japanese officials measure the start of a recession from the point at which growth starts slowing. A more widely used definition is two quarters of contraction in GDP.

'If industrial output falls for three straight quarters, that would be a strong sign of a recession,' said Hirokata Kusaba, a senior economist at Mizuho Research Institute.

'The BOJ has little choice but to downgrade its economic view.'

The government has acknowledged that Japan is either heading into a recession or is already there, ending a growth cycle that began in early 2002 and was the longest in six decades.

But many economists expect any recession to be a shallow one as companies are now more resistant to external shocks, having recovered from the so-called triple excesses of the bubble era in the late 1980s - excess production capacity, heavy debt loads and bloated payrolls. -- REUTERS