The Bank of Japan said Wednesday that the country's economic recovery "has paused" because of the slowing global economy, as it left its key rate unchanged at between zero and 0.1 percent.
"The pick-up in Japan's economic activity has paused, mainly due to the effects of a slowdown in overseas economies and of the appreciation of the yen," the central bank said after a two-day policy meeting.
"Improvement in business sentiment has slowed on the whole despite steady improvement in domestic demand-oriented sectors," the bank said in a statement.
It warned the European financial crisis was posing a serious risk to the world economy.
"The sovereign debt problem in Europe could result in weaker growth not only in the European economy but also in the global economy, particularly through its effects on global financial markets," it said.
Many analysts expect the BoJ to take further easing steps – such as expanding its asset-buying facility – over coming months amid increasing global economic strife, especially in Europe.
Reflecting the global uncertainty and persistent strength of the yen, which has hovered near post-war highs for months, the bank's quarterly Tankan survey of sentiment in major Japanese manufacturers plunged in December to "minus four" from positive "two" in September.
The figures represent the percentage of companies saying business conditions are good minus those saying conditions are bad. The survey is taken into account by the BoJ when formulating monetary policy.
"As for the outlook, Japan's economic activity will remain more or less flat for the time being," the bank said.
"After that, the economy is expected to return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and (as) reconstruction-related demand after the earthquake disaster gradually materialises."
In October, the BoJ said it would boost its asset buying fund to 55 trillion yen ($707 billion) from 50 trillion yen to help pour more liquidity into the market, with the extra amount earmarked for the purchase of Japanese government bonds.
Bank of Japan governor Masaaki Shirakawa is scheduled to hold a regular news conference later in the day.
-- Dow Jones Newswires contributed to this report --
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