'The Japanese economy is slowing due to the drop in housing investment and will likely keep slowing for the time being,' Bank of Japan Gov. Toshihiko Fukui told a parliament panel.

'But the economic recovery cycle is still intact and the economy is expanding as a trend,' Mr Fukui said.

Mr Fukui's remarks came after bearish comments made on Thursday by the central bank's deputy govenor, Toshiro Muto, and further cemented expectations the Japanese central bank will not raise interest rates soon.

'The central bank will take appropriate policy action... while closely watching the risks facing the Japanese economy and confirming whether Japan's economy has achieved sustainable economic growth,' Mr Fukui said.

Mr Fukui also voiced concerns over the global economy, saying downside risks for the US and the global economies were growing.

Global stock markets remain volatile, he added.

The BOJ last raised its key policy interest rate in February, from 0.25 per cent to 0.5 per cent.

The central bank was widely expected to raise rates further, but held off to monitor the economy as problems from defaults on risky mortgages in the US spread around the globe.

Slow growth
Annual growth Japanese bank loans was the slowest in nearly two years in December, reflecting companies' growing cautiousness in light of an uncertain economic outlook.

Outstanding loans held by most Japanese banks rose 0.1 per cent in December from a year earlier, Bank of Japan (BOJ) data showed on Friday, the smallest rise since January 2006.

'Lending by city banks fell sharply, which can be partly explained as a reaction to strong growth in December last year,' said Takeshi Minami, chief economist at Norinchukin Research Institute. 'But it might also reflect shrinking demand for funds by smaller firms, whose business activity is slowing.'

Financial markets showed little reaction to the data as players see little chance of a BOJ rate hike from the current 0.5 per cent in the near future, in view of shaky global markets and growing concerns about slowing US growth and Japan's economic outlook.

Swap contracts on the overnight call rate are pricing in virtually no chance of a rate rise in the next several months.

Bank lending turned around in February 2006, showing increases in each month since than after a steady string of falls since 2001, on the back of the economy's steady recovery - now in its longest postwar growth cycle.

But the pace of growth has slowed since peaking at 2.0 per cent in July 2006 when the central bank started raising rates after holding them at zero for years.

The pace of growth last month was the slowest since January 2006 when it was -0.0 per cent, a BOJ official told reporters. Lending by city banks fell 1.7 per cent, the biggest drop since January 2006, when it fell by the same amount.

However, lending was still growing moderately because of demand from individuals, the official said.

The BOJ data showed that loans held by Japan's four main categories of banks, including 'shinkin', or credit unions, stood at 453.947 trillion yen ($4.149 trillion).

Excluding special factors such as loan write-offs, the loan balance rose 0.8 per cent from the same month a year earlier.

Separate BOJ data showed Japan's most widely watched measure of money supply - M2 plus certificates of deposit (CDs) - rose 2.1 per cent in December from a year earlier, above economists' forecast for a 2.0 per cent rise.

Money supply, as measured by M2+CD, has been growing steadily while growth of quasi-money including time deposits has picked up since the Bank of Japan started tightening credit in 2006.

Quasi-money grew 4.6 per cent in December, after having hit a high of 4.7 per cent in July, while investment trusts rose 27.6 per cent.

Growth in investment trusts - a component of broadest liquidity but not M2 plus CDs - has been slowing since peaking in July last year at 34.4 per cent due in part to fallout from US subprime mortgage problems.

Broadest liquidity was up 3.6 per cent, against the median forecast of economists for a 3.5 per cent rise.

A new Japanese law obliging financial institutions to explain investment risks to customers to protect them from fraud has also been blamed for faltering demand for riskier assets such as investment trusts. -- AP