Bank of Japan wins praise for action but impact doubted

October 6, 2010
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, TOKYO, Oct 6 – The Bank of Japan earned government praise for adopting a near zero-rate policy and new pump-priming measures, but analysts question what impact the action will really have on the flagging economy.

On Tuesday the central bank bowed to recent government pressure, cutting its key rate for the first time since December 2008 from 0.1 percent to between zero and 0.1 percent, pledging to hold it there until deflation is beaten.

It also announced plans to set up a 5 trillion yen (60 billion dollar) asset purchase scheme to lower borrowing costs and risk premiums, adding to earlier 30 trillion yen efforts to boost liquidity and spur growth.

Having come under recent criticism that previous deflation-fighting efforts had been too weak, the bank was applauded by government officials, with finance minister Yoshihiko Noda welcoming the "appropriate and prompt" action.

But analysts argue that, far from being the "comprehensive monetary easing" that the BoJ claimed the actions to be, the move will do little to shore up an economy threatened by a strong yen that is hampering export growth.

"Since there was already little doubt that interest rates would remain close to zero for the foreseeable future, this is arguably not much of a shift," noted Capital Economics in a research note.

Despite falling immediately after the BoJ announced its move, the yen later strengthened towards 15-year highs against the dollar, with the greenback fetching 83.17 yen in Wednesday trade.

Japan is seen as hamstrung by developments overseas — with various central banks expected to boost money supply to combat sluggish growth in their own economies — amid the looming spectre of deflation.

With the US Federal Reserve expected to adopt further measures to increase dollar supply to shore up the US economy, this would soften the greenback and further pressure Japan\’s sagging export-led recovery, say analysts.

"Markets are focused not on the blanks the BoJ fires but on the most powerful handgun in the world: the Fed\’s (expected quantitative easing measures) and the FOMC (Federal Open Markets Committee) meeting next month," said Nicholas Smith of MFGlobal in Tokyo.

Japan stepped into the currency markets in September for the first time since 2004 in a bid to stem the yen\’s strength after it hit a 15-year high against the dollar, and has repeatedly warned it is ready to do so again.

But "the greenback should stay prone to weakening, and, therefore, pressures on the BoJ for easing will unlikely let up anytime soon," noted BNP Paribas chief economist Ryutaro Kono.

"Whether the BoJ will ease further depends more on forex trends than on economic growth."

The strong yen has hurt Japan\’s exporters, making their goods more expensive and eroding overseas profits when repatriated. Exports expanded at their slowest pace this year in August, with falling demand adding to their woes.

A strong domestic currency also makes imports cheaper, helping prolong a damaging deflationary cycle where consumers hold off on purchases in the hope of further price drops, clouding future corporate investment.

Various governments from Colombia to Japan have moved or are planning to intervene in foreign exchange markets to weaken their own currencies and make exports cheaper, prompting warnings that they threatening the global recovery.

Analysts also argued that the planned five trillion yen fund to buy assets such as government bonds, commercial paper and corporate bonds was not sufficient, representing around 1.0 percent of the total money supply.

Between November 2001 and April 2002, the bank raised money supply "at an annualised rate of 88 percent: deflation continued unabated and the yen strengthened regardless," noted MFGlobal\’s Smith.

Of the fund, "only 1.5 trillion yen will go into private sector assets, of which 1.0 trillion will be debt and the BoJ is reflexively reluctant to take significant risk onto its balance sheet," noted Richard Jerram of Macquarie Bank.

"Despite the BoJ hyperbole, the changes are likely to have minimal impact."

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