Japan's economic growth in the next two years will slow to about half that of 2004, but strong exports and corporate restructuring will keep the expansion sustained, the OECD said today.
The OECD forecast Japan's growth at 2.9 per cent for calendar 2004, 1.4 per cent in 2005 and 1.5 per cent in 2006. It noted that deflation and weak state finances remained among several areas of concern.
"The strengthening of the economy has raised hopes that Japan is emerging from a decade of stagnation," the OECD said in a survey, adding the economy was "in its best state in a decade".
Japan's economic recovery has slowed in recent months after a surge at the start of 2004, as moderating demand from overseas slowed exports and output.
The OECD said that sustained growth would bring an end to Japan's deflation, but that the Bank of Japan (BOJ) should maintain its hyper-loose monetary policy until inflation is sufficiently high to make the risk of renewed deflation negligible.
To make sure of this, and to prevent a sharp rise in interest rates, the BOJ should raise its condition for ending the policy until inflation was about 1 per cent from the current zero.
"Setting a higher inflation threshold of perhaps 1 per cent as a condition for changing monetary policy would help to guide market expectations and prevent a premature reaction."
But the OECD also said keeping the "quantitative easing" framework, which floods money markets with liquidity, for too long could stoke inflation, underscoring the dilemma facing the central bank.
The OECD noted a number of short-term risks for Japan's recovery that could weaken growth, including high oil prices and slower world trade growth that reflects cooling demand in China, as well as a sharp appreciation of the yen.