Slowing exports, worsening business sentiment and soft capital spending are challenging the central bank's view that the world's third-largest economy will recover early next year.

In a sign of the growing damage from the global slowdown, Japan's exports fell at their fastest annual pace in six months in November with shipments to Asia declining on weak demand for semiconductor chips and digital cameras.

The BOJ held off on offering additional monetary stimulus, as widely expected, but cut its economic assessment to say that the pickup in economic activity was pausing due to the effect of slowing overseas growth and the yen's strength.

It also revised down its view on export and output growth to say it is flattening, and sounded slightly more gloomy on the outlook, warning that the economy will resume recovery only after a brief period of stagnation.

"Japan's economy will remain more or less flat for the time being" before resuming a moderate recovery, the central bank said in a statement announcing the policy decision.

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Global interest rates link.reuters.com/myt65s

BOJ, Fed balance sheets link.reuters.com/nyt65s

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MORE EASING SOON?

Japan's economy rebounded from a recession triggered by the March earthquake and tsunami, but is expected to slow sharply this quarter as the initial spurt driven by companies restoring supply chains and production facilities tails off.

Many in the bank are counting on support for growth from fiscal spending for reconstruction from the March disaster, but that may not be enough to offset weakening overseas demand.

"The bleaker economic assessment is no surprise given slumping exports that show weakness not only in Europe but Asia as well. The BOJ's longer-term forecast of a moderate recovery is subject to skepticism," said Masamichi Adachi, senior economist at JPMorgan Securities Japan.

Analysts say the BOJ may ease policy again by March next year with the most likely trigger a renewed spike in the yen or market turmoil caused by Europe's crisis.

"We expect the BOJ to implement additional easing steps in January-March as there is a chance the yen will appreciate further during that period," said Takahide Kiuchi, chief economist at Nomura Securities.

"Another trigger could be a credit rating downgrade for European sovereign debt. If that happens and causes financial market turmoil, coordinated monetary easing with U.S. and European central banks could be a possibility."

Central banks are flooding markets with liquidity as markets remain on edge about Europe's ability to put a floor under a bond market selloff that is pushing borrowing costs for countries such as Italy and Spain towards unsustainable levels.

The Fed has pledged to keep interest rates near zero until mid-2013 and the ECB cut its main interest rate to a record low this month, as the fallout from Europe's debt crisis stoked fears of a global economic slump.

The BOJ, too, has kept rates virtually at zero and eased policy in October by topping up its asset buying scheme to ease the pain from sharp yen rises on the export-reliant economy.

It stood pat since then but has expressed its readiness to inject huge amounts of liquidity in market operations and loosen monetary policy to fend off any contagion from Europe as it sees a global credit crunch as a real potential risk.

(Additional reporting by Rie Ishiguro, Kaori Kaneko and Tetsushi Kajimoto; Editing by Joseph Radford and Chris Gallagher)

• A Permanent Economic Emergency