(Adds Nikkei share average decline)
By Leika Kihara
UTSUNOMIYA, Japan, Jan 29 (Reuters) - The Bank of Japan may seek to lower longer-term interest rates, the bank's deputy governor suggested on Thursday, as he warned that global market tensions are crippling Japanese banks and their ability to lend.
The central bank should examine possible market operation tools to achieve that, Kiyohiko Nishimura said on Thursday, as it has little room to cut its overnight call-rate target after lowering it to 0.1 percent last month.
"As tensions in global financial markets continue, pushing down stock prices and boosting credit costs, Japanese financial institutions' businesses and their fund transmission mechanism are gradually being affected," he told business leaders in Utsunomiya, a city about 100 km (60 miles) north of Tokyo.
A global economic slump since late last year has virtually frozen Japanese exports and production of cars and electronics, and the economy may be on track for its longest recession in modern times.
On top of rate cuts, the Bank of Japan has decided to buy corporate debt to smooth corporate funding, but Nishimura signalled that more could be done by lowering the longer-term rates at which companies raise funds.
The three-month TIBOR rate, often used as a benchmark for corporate lending, has been stuck around 0.70 percent, a hefty 60 basis points above the overnight call rate target of 0.10 percent.
Nishimura indicated that the bank could provide funds for longer periods than it does now in its regular operations, saying such operations helped push down longer-term interest rates in the past.
"I suspect he wants to bring down the TIBOR rate a bit," said Koji Ochiai, senior economist at Mizuho Investors Securities.
Ochiai said the BOJ may need to provide more funds to bring down the corporate lending rate as investors, fearful of a deteriorating economy, remain wary of lending for longer periods.
Nishimura, however, warned that intervening too much in markets could distort proper market functions in Japan, where banks were still lending money to companies and markets were not as seized up as in the United States.
Nishimura said he expected the economy to start recovering late this year but added the risks of a delay were growing and global steps to combat the financial crisis may not be enough.
"Nishimura's remarks confirmed that the BOJ is very keen on downside risks. The remarks appear to suggest the BOJ is ready for more steps to ease businesses' credit problems," said Takeshi Minami, chief economist at Norinchukin Research Institute.
"Even if financial institutions' losses from the current crisis are determined, positive developments will be slow to come as it will be difficult to find parties willing to take risks."
Adding to a deepening recession in the world's No. 2 economy, retail sales posted their biggest fall in almost four years in December from a year earlier as growing job concerns and wobbly share markets prompted consumers to tighten their purse strings.
The Japanese government officially declared on Thursday that the economy was in recession, saying the previous boom that started in February 2002 had peaked in October 2007.
BANKS SQUEEZED
Japanese companies have complained of tightening financial conditions, and there are growing fears that otherwise healthy companies are being driven to the wall because they cannot obtain working capital -- especially smaller firms that are key suppliers to major corporates and collectively employ 70 percent of Japanese workers.
Banks are caught between firms seeking more loans because the credit market has frozen, and falling share prices that have cut the value of the banks' large stock portfolios.
Tokyo's benchmark Nikkei share average has plunged 37 percent in the past six months.
Nishimura has mostly toed the BOJ's official line on monetary policy and voted for its interest rate cuts that have reduced the key policy target to 0.1 percent, and purchases of corporate debt to ease credit strains from the global financial turmoil.
Data released on Thursday showed retail sales fell 2.7 percent in December from a year earlier, a much bigger fall than the median market forecast for a 1.6 percent decline. It was the largest slide since a 2.8 percent fall in February 2005. "This is a very weak reading. Sales are falling even though some department stores started holiday sales earlier than usual. Households are becoming very cautious," said Hiroshi Shiraishi, an economist at BNP Paribas.
Wholesale prices fell 13.9 percent from a year earlier in December, the largest fall on records going back to 1980.
Economists expect industrial output figures for December, due on Friday, to show a fall of 9.0 percent, surpassing the record 8.5 percent fall in November. Exports plunged a record 35 percent in December from a year earlier, data showed last week. (Additional reporting by Hideyuki Sano; Editing by Hugh Lawson)