"The economy is cruising at above potential and from now on inflation pressures will pick up," said Chikahisa Sumi, a director in the Financial Bureau of the Japanese Ministry of Finance, during a conference yesterday in New York.

The economy will grow 2.2 percent in 2007, the fastest since 1996, the MOF estimates. The general consumer price index will rise 0.5 percent this year, from 0.2 percent in 2006. Higher inflation may prompt the Bank of Japan to raise its benchmark borrowing cost above the current 0.5 percent, the lowest among major economies.

Japan's low rates are encouraging companies to refurbish factories and add capacity, fueling wage growth and inflation. Business investment surged 13.6 percent to a record in the first quarter from a year earlier, the Finance Ministry said on June 3. The jobless rate fell to 3.8 percent in April, the lowest level since 1998.

The world's second-largest economy grew at an annual 3.3 percent rate in the first quarter. Consumer prices may have fallen 0.1 percent last month, according to the median forecast of 32 economists in a Bloomberg forecast. It was unchanged in April.

The BOJ hasn't increased rates since its 0.25 percent increase in February. Consumer prices rose 0.2 percent last year and fell 0.1 percent in 2005.

Heading out of deflation

"Japan is finally heading out of deflation and we are going to see the BOJ accelerate interest rate hikes," said Tetsufumi Yamakawa, a co-director of Pan Asia Economics Research at Goldman Sachs Group in Tokyo.

Goldman forecasts the BOJ will raise the bench overnight call rate up to 2 percent by the end of next year as the economy grows 2.4 percent in 2007 and 2.6 percent in 2008, Yamakawa said.