WASHINGTON (Kyodo) The International Monetary Fund on Wednesday urged Japan to limit its interest rate hikes and continue structural reforms to ensure a healthy recovery and to prevent the economy from losing to deflation.

In its semiannual “World Economic Outlook” report, the IMF made the recommendations as part of global efforts to deal with downside growth risks.

It also slightly trimmed its projection for Japan’s economic growth in 2006.

The IMF said Japan’s economy is projected to grow by 2.7 percent in 2006 in terms of real gross domestic product, down by 0.1 percentage point from the April forecast but up from 2.6 percent in 2005 on “solid domestic demand.” The growth is expected to ease to 2.1 percent in 2007 as “the cycle matures,” revised up by 0.1 point from April.

Global growth is projected to reach 5.1 percent for 2006, up 0.3 point from April and accelerating from 4.9 percent in 2005, and 4.9 percent in 2007, up 0.2 point.

“In Japan, interest rate increases should be gradual, as there is little danger of an inflationary surge, while the re-emergence of deflation would be costly,” even though recent price data “have confirmed the end of entrenched deflation,” the IMF said.

“With actual inflation barely positive and estimates of trend inflation — a measure of expected average inflation — just above zero, risks of a relapse into deflation in response to an adverse shock, such as a substantial slowing in global growth, cannot be ignored.”

Japan also should continue structural reforms to bolster its growth potential, prioritizing public-sector overhauls, steps to enhance labor market flexibility and financial-sector efficiency as well as the improvement of productivity in the service sector, the IMF said.

But it said the current near-term risks to Japan’s growth outlook “are broadly balanced,” and its expansion “could be boosted by stronger-than-expected domestic demand, as confidence remains high and the pace of household-income growth may pick up with the continued expansion.

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