Japan signals end of world's
cheap money era By Hisane Masaki
In a historic policy change, the Bank of
Japan (BOJ) on Thursday scrapped its five-year-old
super-loose monetary policy and returned to a more
conventional regime, but said it would still keep
short-term interest rates around zero for some
time.
The BOJ's nine-member policy board
decided by a 7-1 vote (one member was absent
because of illness) to switch to the unsecured
overnight call rate as a monetary adjustment target,
rather than using the
outstanding balance of current-account deposits
held by private financial institutions at the
central bank. Two government representatives - one
from the Finance Ministry and another from the
Cabinet Office - attended the policy board meeting
as observers. But they did not invoke their rights
to request the postponement of the vote on a
policy change until another meeting. The board
decision is made by a majority vote. The two
government observers have no voting right.
Thursday's decision marked the first time
in about 15 years, except a brief period in which
the BOJ hastily lifted the zero-interest rate
policy from the summer of 2000 to early 2001, that
the central bank had reversed its policy to one of
tightening.
BOJ governor Toshihiko Fukui
told a news conference the central bank made the
policy change as an uptrend in consumer prices has
taken root amid the steady economic recovery,
which fulfilled the central bank's self-imposed
conditions for lifting the ultra-loose policy.
Fukui had said earlier that the end to
"quantitative easing" wouldn't mean an immediate
tightening in policy but would be a stepping stone
toward a more "normal" monetary policy and "a
return to more neutral interest rates".
The BOJ had vowed that it would stick to
the quantitative easing policy until deflation,
which has long plagued the Japanese economy by
depressing corporate earnings and wages, is
beaten. The BOJ had specifically said it would
maintain the quantitative easing policy until
year-on-year changes in the core consumer price
index (CPI), which excludes volatile prices of
fresh foods, remain stable above zero.
Under the quantitative easing policy,
which the BOJ introduced in March 2001, the bank
has flooded the nation's financial market with
excess cash in the hope of encouraging borrowing
and lending, while anchoring short-term interest
rates at near zero. But with a recent spate of
economic data showing that a recovery is taking
root and persistent deflation is abating in the
world's second-largest economy, the BOJ's
departure from the ultra-loose monetary policy as
early as this week had been widely expected.
Japan's gross domestic product (GDP), the
total value of goods and serviced produced in a
nation, expanded for the fourth quarter in a row
during the October-December quarter, posting a
robust 1.4% growth from the previous quarter and
an annualized 5.5% growth in real, or
price-adjusted, terms. The year-on-year change in
the core CPI has been out of negative territory
for four straight months from October, with the
latest data for January showing a rise of 0.5%.
Meanwhile, the BOJ's policy shift signals
that an era of cheap money around the world is
drawing to a close, boosting the risk of
volatility in global financial markets. Interest
rates have been rising in the United States since
2004 and they recently began heading higher in
Europe as well. The US Federal Reserve raised
interest rates for the 14th time in a row at the
end of January. Borrowing costs rose a quarter of
a percentage point to 4.5%. Rates have increased
from 1% over the past 19 months and are now at
their highest level since April 2001. The European
Central Bank (ECB) also raised interest rates by a
quarter of a percentage point to 2.5% this month -
the second change in rates in four months.
In Japan, as the BOJ has pumped a massive
amount of liquidity to maintain a balance of 30
trillion to 35 trillion yen of current accounts
held by private banks at the central bank, the
unsecured overnight call rate, which serves as the
money-market benchmark, has stayed at
0.001-0.002%. But the current-account balance is
expected to decline to the legally required level
of about 6 trillion yen (US$50.7 billion) in
several months. As the supply of funds tightens,
there had been fears that the overnight call rate,
which banks charge one another, could spike.
Japan's official discount rate, at which the BOJ
provides funds to financial institutions facing
liquidity constraints, is 0.1%.
Market
participants, not only in Japan but also abroad,
have been closely watching the effects of the
BOJ's move, whose implications are not limited to
the Japanese economy alone. Analysts point out
that the process the BOJ has started after more
than a decade of near-zero interest rates and five
years of quantitative easing could ripple through
global capital markets for years to come. Some of
the excess cash the BOJ pumped into the financial
system has flown into higher-yielding investment
choices, including US Treasuries and bonds of
India and other emerging economies.
There
are concerns in the United States that if Japanese
rates rise, Japanese capital that has flown into
the US could start to return home. Foreign
investors, who have already played a leading role
in the rally on the Japanese stock market in the
past year or so, could begin investing more
broadly in Japanese assets. This could push US
interest rates higher and the dollar lower, as
Japanese investors shift away from US assets.
The closely watched timing of the BOJ's
interest-rate rises depends on price movements
down the road. What the BOJ said, and the new
policy framework it adopted for monetary policy on
Thursday, suggest that the central bank is very
likely to begin to move toward interest-rate hikes
once the CPI rises by 1% or more.
Clear
message to markets In announcing the
decision to end its ultra-easy policy, the BOJ
sent a clear message that the transition toward
what Fukui calls "more neutral interest rates"
will be slow, saying benchmark interest rates will
remain near zero for some time and that it will
only gradually reduce the amount of liquidity in
the banking system. The BOJ is widely expected to
keep interest rates around zero, where they have
been for most of the past seven years, at least
until the second half of this year.
The
central bank said it will gradually lower the
current account deposit balance toward the legally
required level of around 6 trillion yen from the
current range of 30 trillion to 35 trillion yen
over a period of a few months to ensure stability
in the financial markets. Fukui indicated that the
BOJ will maintain roughly the current level until
the end of March, taking into account expected
strong demand for funds toward the March 31 end of
fiscal 2005. Fukui also said he wasn't also
implying that once the account balance is lowered
to the legally required level, short-term rates
would soon start to rise above 0%.
In a
bid to prevent a sharp rise in long-term interest
rates, the central bank also said it will continue
to buy 1.2 trillion yen worth of government bonds
a month outright ''for some time'' to help prevent
volatility in the bond market. Fukui said,
however, that the BOJ must "eventually" reduce its
buying of outright Japanese government bonds at
some point from the present 1.2 trillion yen per
month. He added that, in doing so, the BOJ will
"take appropriate steps so as not to shock
financial markets".
The government does
not want to see any hasty interest-raising move by
the BOJ for fear of sharp rises in long-term
interest rates, which would lead to a rise in
government debt-servicing costs. Japan's fiscal
condition is the worst among major industrialized
countries, with public debts, including those owed
by local governments, expected to reach 775
trillion yen at the end of fiscal 2006, or about
150% of the nation's GDP. The Finance Ministry
estimates that every 1% rise in long-term interest
rates, which are now around 1.6%, the government
debt-servicing cost will increase by at about 1.5
trillion yen or more. The fiscal 2006 government
budget plan, now pending in the diet (parliament),
calls for 18.8 trillion yen in debt-servicing
outlays. Of this amount, 8.6 trillion yen will be
used to make interest payments.
New
policy framework With Thursday's policy
change, the BOJ also adopted a new policy
framework for monetary policy aimed at guiding
market expectations now that the quantitative
easing has been abandoned. According to the new
framework, the BOJ policy board will "review its
basic thinking on price stability, and disclose a
level of inflation rate", which it believes
reflects price stability from a medium- to a
long-term perspective. That level currently
translates into annual core consumer-price changes
of about 0% to 2%, and most board members' median
figure is around 1%, the BOJ said.
The
introduction of the desirable price-rise range is
widely seen as a compromise with the government
and the ruling coalition to gain their support for
a policy shift as they have proposed setting an
inflation target to raise the price increase rate
to a certain level. The majority of the
nine-member BOJ policy board members have been
opposed to - or at least reluctant about - the
idea, raising questions about the effectiveness of
such a target and claiming that it would become
difficult for the central bank to implement
flexible monetary policies.
Setting an
inflation target would have the merit of boosting
transparency in BOJ policy, but at the same time
it would have the demerit of depriving the central
bank of room for flexible policy implementation.
Fukui stressed that the presented price range is
different from an inflation target adopted by
overseas central banks such as the Bank of England
or the more relaxed inflation reference target
employed by the ECB.
Prime Minister
Junichiro Koizumi had suggested on Monday that he
didn't think the time was ripe for a policy
change, saying the economy was still not out of
deflation. But on Thursday, after the BOJ's policy
turnaround, the prime minister said he respected
the central bank's decision to end the
quantitative easing, as he believes it was made
after thorough discussions. Koizumi also said the
BOJ's release of the board's view that price
stability would mean on-year changes in the CPI of
between 0% and 2% was a message that the central
bank was willing to continue cooperating with the
government to fight deflation.
Economy
Minister Kaoru Yosano also said on Thursday that
it's too early to start talking about lifting
short-term interest rates, but praised the
increased transparency of the central bank. The
new BOJ policy framework also "gives higher
predictability to markets and the public and is
praiseworthy because (the BOJ) is fulfilling its
responsibility to explain" its policies, he said.
When asked about the BOJ-presented price
range, Yosano said it was neither a reference rate
nor a target. Rather, the spread given by policy
board members and its mid-range of "a bit above or
below a positive 1%" gives predictability to
markets and the public. While most government and
Liberal Democratic Party (LDP) officials praised
the BOJ's new policy framework, Heizo Takenaka, a
former Harvard academic and influential member of
Koizumi's cabinet, expressed dissatisfaction that
the BOJ had failed to set a clear-cut inflation
target.
The BOJ said it will review the
desirable price-rise range roughly every year.
Fukui suggested that the central bank has no
intention to be bound by the figure over monetary
policy, saying that the BOJ is confident that it
will ensure ''transparency'' and ''mobility''
under the new framework. The BOJ added that it
will gradually adjust short-term interest rates in
line with economic and price conditions after the
period of effectively 0% interest rates. Some
private-sector economists said the new policy
framework is ambiguous enough to allow the BOJ to
conduct monetary policy more freely than during
the era of the quantitative easing framework.
The BOJ's move toward higher rates is
widely expected to be gradual and slow, however.
If that is the case, the BOJ's policy shift will
have little, if any, negative impact on corporate
Japan, analysts say. Some say that since growth in
the core CPI is expected to slow down in April and
beyond, speculation on rate rises by the end of
the year has receded. Some analysts also believe
that the BOJ may find it difficult to raise rates
until the core CPI exceeds 1%, the median figure
on consumer price rises released by the central
bank on Thursday. Some also say that the BOJ will
be very cautious about raising rates because it
remains traumatized by its policy debacle in the
summer of 2000, when it prematurely lifted - and
was forced to restore only months later - its
zero-interest-rate policy.
Some analysts
said that the desirable price-rise range of 0%-2%,
released by the BOJ, will likely dispel
speculation on an imminent rise in interest rates.
In fact, the stock market reacted positively to
the BOJ action on Thursday as investors perceived
the policy change as putting an end to weeks of
market uncertainty, with the benchmark 225-issue
Nikkei Stock Average jumping 2.62% to end above
the 16,000 line for the first time since February
28.
After the announcement of the BOJ's
decision, the US dollar temporarily topped 118
yen, while the yield on the benchmark 10-year
Japanese government bond briefly fell below 1.6%
for the first time in a week. The yen fell against
the dollar on the likelihood that interest rates
would stay low, although the yen strengthened
later in the day.
Until the BOJ's Thursday
decision, there were strong concerns that
long-term interest rates could rise sharply if
market players act according to what they think
the central bank will choose to do once it
jettisoned its ultra-easy monetary policy.
Expectations for a policy change already had
spurred selling in Japan's stock market, as an
eventual increase in interest rates could
discourage individual investors' purchases of
stocks, while hurting earnings of many
export-reliant Japanese companies by pushing the
value of the yen higher against the dollar.
Seeds of new conflict Koizumi is
to step down as prime minister in September when
his current three-year term as president of the
ruling LDP expires. Completely defeating deflation
and putting the Japanese economy back on a solid
growth track will probably be remembered as the
biggest accomplishment he made during more than
five years in office. Meanwhile, for BOJ governor
Fukui, whose term expires in two years' time,
returning interest rates to "neutral" levels that
neither overheat nor kill growth is widely seen as
his ultimate goal.
In announcing the
decision to end the quantitative easing, Fukui
emphasized that the domestic economic conditions
for doing so had been met. But some analysts
believe other factors played a role in the timing
of the central bank's decision. One factor is the
US Federal Reserve Board's Federal Open Market
Committee (FOMC) meeting, slated for March 28. The
Fed's cycle of rate hikes could pause at or after
the next FOMC meeting. If the BOJ had lifted the
quantitative easing policy, it could have sparked
a sharp rise in the value of the yen to the US
dollar, something the BOJ wanted to avoid.
Another factor is domestic politics. Some
market participants say Koizumi will officially
declare an end to deflation before stepping down
in September and that such a declaration will make
it politically easier for the BOJ to begin to
raise rates. Some analysts believe the BOJ decided
to depart from the quantitative easing policy at
this time to have enough time to prepare itself
and markets for a rate hike around that time.
Although the LDP-led government and the
BOJ had often clashed over policy, especially the
timing of scrapping the quantitative easing, they
seem to have reached a ceasefire, at least for
now. But the desirable levels of price rises
announced by the BOJ may have sowed the seeds of
new conflict. Although Fukui insisted that the
announced desirable levels of price rises are not
a binding target that binds the central bank's
policy implementation, it is possible that the
government will put political pressure on the
central bank over what it deems any hasty move
toward rate hikes as long as price rises remain
below 2%.
Hisane Masaki is a
Tokyo-based journalist, commentator and scholar on
international politics and economy. Masaki's
e-mail address isyiu45535@nifty.com.
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