Posted by: Kenji Hall on October 29, 2008
Could the market turmoil force Japan’s central bank to push interest rates even lower than 0.5%? That’s one possible outcome of the Bank of Japan’s monetary policy meeting on Oct. 31, according to media reports today. If BOJ chief Masaaki Shirakawa and other policymakers vote for monetary easing, it would be the first time since March 2001. Some observers think it could help in weakening the yen, which has gained 8% against the dollar and 17% against the euro this month.
The move would also signal a policy about-face for the BOJ. After Japan’s central bank abandoned its zero interest-rate policy—an extraordinary measure designed to give the economy leeway to recover—in mid-2006, it raised short-term rates to 0.25%. It tacked on another 25 basis points in February 2007. Since then, BOJ officials have expressed their eagerness to continue the rate hikes, to bring Japan more in line with other wealthy nations.
But recently that has left Japan at odds with other countries. Earlier this month, the U.S. Federal Reserve coordinated a rate cut with the central banks of a handful of countries, in a bid to calm panicky financial markets. U.S. short-term rates, above 5% as recently as last year, are now at 1.5%. The BOJ abstained, citing its already low rates. Instead it focused on preventing a credit crunch in the financial system by keeping the money markets awash in cash and encouraging banks to continue lending.
Why is the BOJ holding back? Last week, at a hearing in Parliament, BOJ deputy governor nominee, Hirohide Yamaguchi, offered a clue. Yamaguchi acknowledged that Japan’s ultraloose monetary policy might be partly to blame for financing the high-risk deals in other parts of the world. That suggests the bank is worried about getting slammed for a policy that ultimately helped tip big financial institutions like Lehman Brothers into insolvency. “Some people say that a side effect of our (low-rate) policy is the yen carry trade,” Yamaguchi said, referring to how investors had borrowed money at low rates in Japan and put it into higher-yielding securities in other markets.
But the yen’s surge to 13-year highs in the past week—and the depressing effect it has had on Japanese corporate earnings and global stock markets—has pressured BOJ officials to rethink their approach. And with China’s central bank cutting rates for the third time in six weeks today and the Fed and European Central Bank widely expected to follow with rate cuts of their own, the BOJ risks looking overly timid.
Analysts say the BOJ’s most likely course of action would be to revise downward its forecasts in the October Outlook Report, slated for release Oct. 31. That would provide the rationale for lowering the unsecured overnight call rate target, used in interbank lending, from 0.5% to 0.25%, the Nikkei financial daily, Dow Jones Newswires and others have reported, citing anonymous sources. Market players have begun factoring in the possibility, with overnight interest-rate swaps in Tokyo reflecting a higher than 60% chance for a rate hike, according to JPMorgan Chase & Co. estimates.
The mere suggestion of a BOJ policy change buoyed Tokyo market.
Stocks rallied and the yen fell for the second straight day against the dollar. The Nikkei 225 stock index finished 7.7% higher at 8,211.90, following the previous day’s 6.7% gain on government steps to prevent short-selling (a bet that shares will fall). The dollar had risen to 97 yen and the euro to just shy of 124 yen.
A rate cut in Japan would provide a psychological boost more than anything else. It's unclear whether it will assuage nervous investors, and if it does, for how long.
Economists already think Japan is headed for recession. Morgan Stanley economist Takehiro Sato wrote in a recent report that he expects the BOJ to lower the Outlook Report's growth forecast to 0.5% next fiscal year, starting April 2009, and 0.6% the following year. Sato's own forecasts call for the world's second-largest economy to contract by 0.3% and 0.4%, respectively, over the next two years. Others say it will be worse than that, perhaps by as much as minus 1%. The BOJ has taken its sweet time to act, but few will complain if it finally comes around to taking action to prevent more market losses--and perhaps rougher times ahead.